<PAGE>
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
The date of this Statement of Additional Information is July 1, 1998, or
November 1, 1998 (T.Rowe Price Tax-Exempt Money Fund--PLUS Class only).
T. ROWE PRICE CALIFORNIA TAX-FREE INCOME TRUST
(the "Trust")
California Tax-Free Bond Fund
California Tax-Free Money Fund
and
T. ROWE PRICE STATE TAX-FREE INCOME TRUST
(the "Trust")
Florida Intermediate Tax-Free Fund
Georgia Tax-Free Bond Fund
Maryland Short-Term Tax-Free Bond Fund
Maryland Tax-Free Bond Fund
New Jersey Tax-Free Bond Fund
New York Tax-Free Bond Fund
New York Tax-Free Money Fund
Virginia Short-Term Tax-Free Bond Fund
Virginia Tax-Free Bond Fund
and
T. ROWE PRICE TAX-EFFICIENT BALANCED FUND, INC.
T. ROWE PRICE TAX-EXEMPT MONEY FUND, INC.
T. Rowe Price Tax-Exempt Money Fund--PLUS Class
(A Separate Class of T. Rowe Price Tax-Exempt Money Fund,
Inc.)
T. ROWE PRICE TAX-FREE HIGH YIELD FUND, INC.
T. ROWE PRICE TAX-FREE INCOME FUND, INC.
T. ROWE PRICE TAX-FREE INTERMEDIATE BOND FUND, INC.
T. ROWE PRICE TAX-FREE SHORT-INTERMEDIATE FUND, INC.
_________________________________________________________________
Mailing Address:
T. Rowe Price Investment Services, Inc.
100 East Pratt Street
Baltimore, Maryland 21202
1-800-638-5660
This Statement of Additional Information is not a prospectus but should be
read in conjunction with the appropriate Fund prospectus dated July 1, 1998,
or November 1, 1998 (T. Rowe Price Tax-Exempt Money Fund--PLUS Class only),
which may be obtained from T. Rowe Price Investment Services, Inc.
Shareholders of the T. Rowe Price Tax-Exempt Money Fund--PLUS Class should
refer to the Tax-Exempt Money Fund for information relating to their
investment.
If you would like a prospectus for a Fund of which you are not a shareholder,
please call 1-800-638-5660. A prospectus with more complete information,
including management fees and expenses, will be sent to you. Please read it
carefully.
C03-043 11/1/98
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<TABLE>
<CAPTION>
TABLE OF CONTENTS
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Page Page
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<S> <S> <S> <S> <S>
Capital Stock 75 Pricing of Securities 62
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Code of Ethics 57 Principal Holders of Securities 53
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Custodian 56 Ratings of Commercial Paper 81
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Distributor for the 56 Ratings of Municipal Debt Securities 79
Funds
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Dividends and 64 Ratings of Municipal Notes and 81
Distributions Variable Rate Securities
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Federal Registration 77 Risk Factors 3
of Shares
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Independent 77 Risk Factors Associated with a 8
Accountants California Portfolio
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Investment Management 53 Risk Factors Associated with a 10
Services Florida Portfolio
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Investment Objectives 2 Risk Factors Associated with a 12
and Policies Georgia Portfolio
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Investment Performance 73 Risk Factors Associated with a 14
Maryland Portfolio
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Investment Program 22 Risk Factors Associated with a New 15
Jersey Portfolio
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Investment 42 Risk Factors Associated with a New 17
Restrictions York Portfolio
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Legal Counsel 77 Risk Factors Associated with a 20
Virginia Portfolio
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Management of the Risk Factors Associated with the
Funds 45 Equity Portion of 5
Tax-Efficient Balanced Fund
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Net Asset Value Per 64 Shareholder Services 57
Share
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Organization of the 76 Tax-Exempt vs. Taxable Yields 68
Funds
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Portfolio Management 29 Tax Status 64
Practices
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Portfolio Transactions 57 Yield Information 65
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</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
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The following information supplements the discussion of each Fund's
investment objectives and policies discussed in the Funds' prospectus.
The Funds will not make a material change in their investment objectives
without obtaining shareholder approval. Unless otherwise specified, the
investment programs and restrictions of the Funds are not fundamental
policies. Each Fund's operating policies are subject to change by each Board
of Directors/ Trustees without shareholder approval. However, shareholders
will be notified of a material change in an operating policy. Each Fund's
fundamental policies may not be changed without the approval of at least a
majority of the outstanding shares of the Fund or, if it is less, 67% of the
shares represented at a meeting of shareholders at which the holders of 50%
or more of the shares are represented.
Throughout this Statement of Additional Information, "the Fund" is intended
to refer to each Fund listed on the cover page, unless otherwise indicated.
<PAGE>
RISK FACTORS
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Reference is also made to the sections entitled "Types of Securities" and
"Portfolio Management Practices" for discussions of the risks associated with
the investments and practices described therein as they apply to the Fund.
All Funds
The Funds are designed for investors who, because of their tax bracket, can
benefit from investment in municipal bonds whose income is exempt from
federal taxes. The Funds are not appropriate for qualified retirement plans
where income is already tax deferred.
Because of their investment policies, the Funds may or may not be suitable or
appropriate for all investors. The Funds (except for the Money Funds) are not
an appropriate investment for those whose primary objective is principal
stability. The value of the portfolio securities of the Fund will fluctuate
based upon market conditions. The Tax-Efficient Balanced Fund will normally
have 40-50% of its assets in equity securities. This portion of the
Tax-Efficient Balanced Fund's assets will be subject to all of the risks of
investing in the stock market. There can, of course, be no assurance that the
Funds will achieve their investment objective.
All Funds
Municipal Securities
Yields on municipal securities are dependent on a variety of factors,
including the general conditions of the money market and the municipal bond
market, the size of a particular offering, the maturity of the obligations,
and the rating of the issue. Municipal securities with longer maturities tend
to produce higher yields and are generally subject to potentially greater
capital appreciation and depreciation than obligations with shorter
maturities and lower yields. The market prices of municipal securities
usually vary, depending upon available yields. An increase in interest rates
will generally reduce the value of portfolio investments, and a decline in
interest rates will generally increase the value of portfolio investments.
The ability of all the Funds to achieve their investment objectives is also
dependent on the continuing ability of the issuers of municipal securities in
which the Funds invest to meet their obligations for the payment of interest
and principal when due. The ratings of Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), and Fitch IBCA, Inc.
("Fitch") represent their opinions as to the quality of municipal securities
which they undertake to rate. Ratings are not absolute standards of quality;
consequently, municipal securities with the same maturity, coupon, and rating
may have different yields. There are variations in municipal securities, both
within a particular classification and between classifications, depending on
numerous factors. It should also be pointed out that, unlike other types of
investments, municipal securities have traditionally not been subject to
regulation by, or registration with, the SEC, although there have been
proposals which would provide for regulation in the future.
The federal bankruptcy statutes relating to the debts of political
subdivisions and authorities of states of the United States provide that, in
certain circumstances, such subdivisions or authorities may be authorized to
initiate bankruptcy proceedings without prior notice to or consent of
creditors, which proceedings could result in material and adverse changes in
the rights of holders of their obligations.
Proposals have been introduced in Congress to restrict or eliminate the
federal income tax exemption for interest on municipal securities, and
similar proposals may be introduced in the future. Proposed "Flat Tax" and
"Value Added Tax" proposals would also have the effect of eliminating the tax
preference for municipal securities. Some of the past proposals would have
applied to interest on municipal securities issued before the date of
enactment, which would have adversely affected their value to a material
degree. If such a proposal were enacted, the availability of municipal
securities for investment by the Funds and the value of a Fund's portfolio
would be affected and, in such an event, a Fund would reevaluate its
investment objectives and policies.
<PAGE>
Although the banks and securities dealers with which the Fund will transact
business will be banks and securities dealers that T. Rowe Price believes to
be financially sound, there can be no assurance that they will be able to
honor their obligations to the Fund with respect to such securities.
After purchase by a Fund, a security may cease to be rated or its rating may
be reduced below the minimum required for purchase by the Fund. For the Money
Fund, the procedures set forth in Rule 2a-7, under the Investment Company Act
of 1940, may require the prompt sale of any such security. For the other
Funds, neither event would require a sale of such security by the Fund.
However, T. Rowe Price Associates, Inc. ("T. Rowe Price") will consider such
event in its determination of whether the Fund should continue to hold the
security. To the extent that the ratings given by Moody's, S&P, or Fitch may
change as a result of changes in such organizations or their rating systems,
the Fund will attempt to use comparable ratings as standards for investments
in accordance with the investment policies contained in the prospectus. When
purchasing unrated securities, T. Rowe Price, under the supervision of the
Fund's Board of Directors/Trustees, determines whether the unrated security
is of a quality comparable to that which the Fund is allowed to purchase.
Municipal Bond Insurance All of the Funds may purchase insured bonds from
time to time. The Tax-Free Intermediate Bond and Florida Intermediate
Tax-Free Funds must purchase such bonds. Municipal bond insurance provides an
unconditional and irrevocable guarantee that the insured bond's principal and
interest will be paid when due. The guarantee is purchased from a private,
non-governmental insurance company.
There are two types of insured securities that may be purchased by the Funds:
bonds carrying either (1) new issue insurance; or (2) secondary insurance.
New issue insurance is purchased by the issuer of a bond in order to improve
-------------------
the bond's credit rating. By meeting the insurer's standards and paying an
insurance premium based on the bond's principal value, the issuer is able to
obtain a higher credit rating for the bond. Once purchased, municipal bond
insurance cannot be canceled, and the protection it affords continues as long
as the bonds are outstanding and the insurer remains solvent.
The Funds may also purchase bonds that carry secondary insurance purchased by
-------------------
an investor after a bond's original issuance. Such policies insure a security
for the remainder of its term. Generally, the Funds expect that portfolio
bonds carrying secondary insurance will have been insured by a prior
investor. However, the Funds may, on occasion, purchase secondary insurance
on their own behalf.
Each of the municipal bond insurance companies has established reserves to
cover estimated losses. Both the method of establishing these reserves and
the amount of the reserves vary from company to company. The risk that a
municipal bond insurance company may experience a claim extends over the life
of each insured bond. Municipal bond insurance companies are obligated to pay
a bond's interest and principal when due if the issuing entity defaults on
the insured bond. Although defaults on insured municipal bonds have been low
to date, there is no assurance this low rate will continue in the future. A
higher than expected default rate could deplete loss reserves and adversely
affect the ability of a municipal bond insurer to pay claims to holders of
insured bonds, such as the Fund.
Money Funds
The Money Fund will limit its purchases of portfolio instruments to those
U.S. dollar-denominated securities which the Fund's Board of
Directors/Trustees determines present minimal credit risk, and which are
Eligible Securities as defined in Rule 2a-7 under the Investment Company Act
of 1940 ("1940 Act"). Eligible Securities are generally securities which have
been rated (or whose issuer has been rated or whose issuer has comparable
securities rated) in one of the two highest short-term rating categories
(which may include sub-categories) by nationally recognized statistical
rating organizations or, in the case of any instrument that is not so rated,
is of comparable high quality as determined by T. Rowe Price pursuant to
written guidelines established under the supervision of the Fund's Board of
Directors/Trustees. In addition, the Fund may treat variable and floating
rate instruments with demand features as short-term securities pursuant to
Rule 2a-7 under the 1940 Act.
There can be no assurance that the Money Fund will achieve its investment
objectives or be able to maintain its net asset value per share at $1.00. The
price stability and liquidity of the Money Fund may not be equal to
<PAGE>
that of a taxable money market Fund which exclusively invests in short-term
taxable money market securities. The taxable money market is a broader and
more liquid market with a greater number of investors, issuers, and market
makers than the short-term municipal securities market. The weighted average
maturity of the Fund varies (subject to a 90-day maximum under Rule 2a-7):
the shorter the average maturity of a portfolio, the less its price will be
impacted by interest rate fluctuations.
Bond and Balanced Funds
Because of their investment policies, the Bond and Balanced Funds may not be
suitable or appropriate for all investors. The Funds are designed for
investors who wish to invest in non-money market funds for income, and who
would benefit, because of their tax bracket, from receiving income that is
exempt from federal income taxes. The Bond and Balanced Funds' investment
programs permit the purchase of investment-grade securities that do not meet
the high-quality standards of the Money Funds. Since investors generally
perceive that there are greater risks associated with investment in
lower-quality securities, the yield from such securities normally exceeds
those obtainable from higher-quality securities. In addition, the principal
value of long term lower-rated securities generally will fluctuate more
widely than higher-quality securities. Lower-quality investments entail a
higher risk of default--that is, the nonpayment of interest and principal by
the issuer than higher-quality investments. The value of the portfolio
securities of the Bond and Balanced Funds will fluctuate based upon market
conditions. Although these Funds seek to reduce credit risk by investing in a
diversified portfolio, such diversification does not eliminate all risk.
These Funds are also not intended to provide a vehicle for short-term trading
purposes.
Special Risks of High-Yield Investing The Fund may invest in low-quality
bonds commonly referred to as "junk bonds." Junk bonds are regarded as
predominantly speculative with respect to the issuer's continuing ability to
meet principal and interest payments. Because investment in low- and
lower-medium-quality bonds involves greater investment risk, to the extent
the Fund invests in such bonds, achievement of its investment objective will
be more dependent on T. Rowe Price's credit analysis than would be the case
if the Fund were investing in higher-quality bonds. High-yield bonds may be
more susceptible to real or perceived adverse economic conditions than
investment-grade bonds. A projection of an economic downturn, or higher
interest rates, for example, could cause a decline in high-yield bond prices
because the advent of such events could lessen the ability of highly
leveraged issuers to make principal and interest payments on their debt
securities. In addition, the secondary trading market for high-yield bonds
may be less liquid than the market for higher-grade bonds, which can
adversely affect the ability of a Fund to dispose of its portfolio
securities. Bonds for which there is only a "thin" market can be more
difficult to value inasmuch as objective pricing data may be less available
and judgment may play a greater role in the valuation process.
RISK FACTORS ASSOCIATED WITH THE EQUITY PORTION OF TAX-EFFICIENT BALANCED FUND
Foreign Securities
The Fund may invest in U.S. dollar-denominated and non-U.S.
dollar-denominated securities of foreign issuers.
Risk Factors of Foreign Investing There are special risks in foreign
investing. Certain of these risks are inherent in any mutual fund while
others relate more to the countries in which the Fund will invest. Many of
the risks are more pronounced for investments in developing or emerging
market countries, such as many of the countries of Asia, Latin America,
Eastern Europe, Russia, Africa, and the Middle East. Although there is no
universally accepted definition, a developing country is generally considered
to be a country which is in the initial stages of its industrialization cycle
with a per capita gross national product of less than $8,000.
. Political and Economic Factors Individual foreign economies of certain
countries differ favorably or unfavorably from the United States' economy in
such respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position. The
internal politics of certain foreign countries are not as stable as in the
United States. For example, in 1991, the existing government in Thailand was
overthrown in a military coup. In 1992, there were two military coup attempts
<PAGE>
in Venezuela and in 1992 the President of Brazil was impeached. In 1994-1995,
the Mexican peso plunged in value setting off a severe crisis in the Mexican
economy. Asia is still coming to terms with its own crisis and recessionary
conditions sparked off by widespread currency weakness in late 1997. In
addition, significant external political risks currently affect some foreign
countries. Both Taiwan and China still claim sovereignty of one another and
there is a demilitarized border and hostile relations between North and South
Korea.
Governments in certain foreign countries continue to participate to a
significant degree, through ownership interest or regulation, in their
respective economies. Action by these governments could have a significant
effect on market prices of securities and payment of dividends. The economies
of many foreign countries are heavily dependent upon international trade and
are accordingly affected by protective trade barriers and economic conditions
of their trading partners. The enactment by these trading partners of
protectionist trade legislation could have a significant adverse effect upon
the securities markets of such countries.
. Currency Fluctuations The Fund invests in securities denominated in various
currencies. Accordingly, a change in the value of any such currency against
the U.S. dollar will result in a corresponding change in the U. S. dollar
value of the Fund's assets denominated in that currency. Such changes will
also affect the Fund's income. Generally, when a given currency appreciates
against the dollar (the dollar weakens) the value of the Fund's securities
denominated in that currency will rise. When a given currency depreciates
against the dollar (the dollar strengthens) the value of the Fund's
securities denominated in that currency would be expected to decline.
. Investment and Repatriation of Restrictions Foreign investment in the
securities markets of certain foreign countries is restricted or controlled
in varying degrees. These restrictions limit at times and preclude investment
in certain of such countries and increase the cost and expenses of the Fund.
Investments by foreign investors are subject to a variety of restrictions in
many developing countries. These restrictions may take the form of prior
governmental approval, limits on the amount or type of securities held by
foreigners, and limits on the types of companies in which foreigners may
invest. Additional or different restrictions may be imposed at any time by
these or other countries in which the Funds invest. In addition, the
repatriation of both investment income and capital from several foreign
countries is restricted and controlled under certain regulations, including
in some cases the need for certain government consents. For example, capital
invested in Chile normally cannot be repatriated for one year.
. Market Characteristics It is contemplated that most foreign securities will
be purchased in over-the-counter markets or on stock exchanges located in the
countries in which the respective principal offices of the issuers of the
various securities are located, if that is the best available market.
Investments in certain markets may be made through ADRs traded in the United
States. Foreign stock markets are generally not as developed or efficient as,
and more volatile than, those in the United States. While growing in volume,
they usually have substantially less volume than U.S. markets and the Fund's
portfolio securities may be less liquid and subject to more rapid and erratic
price movements than securities of comparable U.S. companies. Equity
securities may trade at price/earnings multiples higher than comparable
United States securities and such levels may not be sustainable. Commissions
on foreign stocks are generally higher than commissions on United States
exchanges, and while there is an increasing number of overseas stock markets
that have adopted a system of negotiated rates, a number are still subject to
an established schedule of minimum commission rates. There is generally less
government supervision and regulation of foreign stock exchanges, brokers,
and listed companies than in the United States. Moreover, settlement
practices for transactions in foreign markets may differ from those in United
States markets. Such differences include delays beyond periods customary in
the United States and practices, such as delivery of securities prior to
receipt of payment, which increase the likelihood of a "failed settlement."
Failed settlements can result in losses to the Fund.
. Investment Funds The Fund may invest in investment funds which have been
authorized by the governments of certain countries specifically to permit
foreign investment in securities of companies listed and traded on the stock
exchanges in these respective countries. The Fund's investment in these funds
is subject to the provisions of the 1940 Act. If the Fund invests in such
investment funds, the Fund's shareholders will bear not only their
proportionate share of the expenses of the Fund (including operating expenses
and the fees of
<PAGE>
the investment manager), but also will bear indirectly similar expenses of
the underlying investment funds. In addition, the securities of these
investment funds may trade at a premium over their net asset value.
. Information and Supervision There is generally less publicly available
information about foreign companies comparable to reports and ratings that
are published about companies in the United States. Foreign companies are
also generally not subject to uniform accounting, auditing and financial
reporting standards, practices, and requirements comparable to those
applicable to United States companies. It also is often more difficult to
keep currently informed of corporate actions which affect the prices of
portfolio securities.
. Taxes The dividends and interest payable on certain of the Fund's foreign
portfolio securities may be subject to foreign withholding taxes, thus
reducing the net amount of income available for distribution to the Fund's
shareholders.
. Other With respect to certain foreign countries, especially developing and
emerging ones, there is the possibility of adverse changes in investment or
exchange control regulations, expropriation or confiscatory taxation,
limitations on the removal of Funds or other assets of the Funds, political
or social instability, or diplomatic developments which could affect
investments by U.S. persons in those countries.
. Eastern Europe and Russia Changes occurring in Eastern Europe and Russia
today could have long-term potential consequences. As restrictions fall, this
could result in rising standards of living, lower manufacturing costs,
growing consumer spending, and substantial economic growth. However,
investment in the countries of Eastern Europe and Russia is highly
speculative at this time. Political and economic reforms are too recent to
establish a definite trend away from centrally planned economies and
state-owned industries. In many of the countries of Eastern Europe and
Russia, there is no stock exchange or formal market for securities. Such
countries may also have government exchange controls, currencies with no
recognizable market value relative to the established currencies of western
market economies, little or no experience in trading in securities, no
financial reporting standards, a lack of a banking and securities
infrastructure to handle such trading, and a legal tradition which does not
recognize rights in private property. In addition, these countries may have
national policies which restrict investments in companies deemed sensitive to
the country's national interest. Further, the governments in such countries
may require governmental or quasi-governmental authorities to act as
custodian of the Fund's assets invested in such countries, and these
authorities may not qualify as a foreign custodian under the Investment
Company Act of 1940 and exemptive relief from such Act may be required. All
of these considerations are among the factors which could cause significant
risks and uncertainties to investment in Eastern Europe and Russia. The Fund
will only invest in a company located in, or a government of, Eastern Europe
and Russia, if it believes the potential return justifies the risk.
. Latin America
Inflation Most Latin American countries have experienced, at one time or
another, severe and persistent levels of inflation, including, in some cases,
hyperinflation. This has, in turn, led to high interest rates, extreme
measures by governments to keep inflation in check, and a generally
debilitating effect on economic growth. Although inflation in many countries
has lessened, there is no guarantee it will remain at lower levels.
Political Instability The political history of certain Latin American
countries has been characterized by political uncertainty, intervention by
the military in civilian and economic spheres, and political corruption. Such
developments, if they were to reoccur, could reverse favorable trends toward
market and economic reform, privatization, and removal of trade barriers, and
result in significant disruption in securities markets.
Foreign Currency Certain Latin American countries may have managed currencies
which are maintained at artificial levels to the U. S. dollar rather than at
levels determined by the market. This type of system can lead to sudden and
large adjustments in the currency which, in turn, can have a disruptive and
negative effect on foreign investors. For example, in late 1994 the value of
the Mexican peso lost more than one-third of its value relative to the
dollar. Certain Latin American countries also restrict the free conversion of
their currency into foreign currencies, including the U.S. dollar. There is
no significant foreign exchange market for many currencies and it would, as a
result, be difficult for the Fund to engage in foreign currency transactions
designed to protect the value of the Fund's interests in securities
denominated in such currencies.
<PAGE>
Sovereign Debt A number of Latin American countries are among the largest
debtors of developing countries. There have been moratoria on, and
reschedulings of, repayment with respect to these debts. Such events can
restrict the flexibility of these debtor nations in the international markets
and result in the imposition of onerous conditions on their economies.
RISK FACTORS ASSOCIATED WITH A CALIFORNIA PORTFOLIO
The Funds' concentration in debt obligations of one state carries a higher
risk than a portfolio that is geographically diversified. In addition to
State general obligations and notes, the Funds will invest in local bond
issues, lease obligations and revenue bonds, the credit quality and risk of
which will vary according to each security's own structure and underlying
economics.
Debt The State, its agencies and local governmental entities issued $27.9
billion in debt in 1997. Approximately 27% was general obligation debt,
backed by the taxing power of the issuer, and 73% were revenue bonds and
lease backed obligations, issued for a wide variety of purposes, including
transportation, housing, education and healthcare.
As of April 1, 1998, the State of California had approximately $18.3 billion
outstanding general obligation bonds secured by the State's revenue and
taxing power. An additional $4.2 billion in authorized but unissued state
general obligation debt remains to be issued to comply with voter initiatives
and legislative mandates. Debt service on roughly 21% of the State's
outstanding debt is met from revenue producing projects such as water,
harbor, and housing facilities. As part of its cash management program, the
State regularly issues short-term notes to meet its disbursement requirements
in advance of revenue collections. During fiscal 1998, the State issued $3.0
billion in short-term notes for this purpose. California also operates a
commercial paper program which it uses to finance construction projects. $1.2
billion of commercial paper was outstanding as of April 1, 1998.
The State supports $6.5 billion in lease-purchase obligations attributable to
the State Public Works Board and other issuers. These obligations are not
backed by the full faith and credit of the State but instead, are subject to
annual appropriations from the State's General Fund.
In addition to the State obligations described above, bonds have been issued
by special public authorities in California that are not obligations of the
State. These include bonds issued by the California Housing Finance Agency,
the Department of Water Resources, the Department of Veterans Affairs,
California State University and the California Transportation Commission.
Lease finance continues to be an area of controversy in the state. The
California Supreme Court has agreed to review a case which challenges the use
of joint power authorities to issue lease-backed debt. The outcome will have
broad implications for this important market segment. Another court challenge
surrounds the use of transfers from county transportation agencies in Orange
and Los Angeles Counties to address fiscal pressures several years ago. This
case was decided in favor of the counties, but is now on appeal.
Economy California's economy is the largest among the 50 states and one of
the largest in the world. The 1997 population of 33 million represents 12% of
the U.S. total. The State's per capita personal income in 1996 exceeded the
U.S. average by 4%. Weakness in Asian markets could influence California's
future economic momentum; California ranks first in the nation in exports,
with 50% of its exports going to Asia.
California's economy suffered through a severe recession during the early
1990's as the effects of a slowdown in the national economy were compounded
by federal defense spending cuts and military base closings. Since 1994, the
State has been in a steady recovery, positing significant job growth and
gains in personal income. The level of economic activity within the State is
important as it influences the growth or contraction of State and local
government revenues available for operations and debt service.
Recessionary influences and the effects of overbuilding in selected areas
have resulted in a contraction in real estate values in many regions of the
State in prior years. Most areas have begun to show improvement
<PAGE>
corresponding to gains in the general economic level. Future declines in
property values could have a negative effect on the ability of certain local
governments to meet their obligations.
As a state, California is more prone to earthquakes than most other states in
the country, creating potential economic losses from damages. On January 17,
1994, a major earthquake, measuring 6.8 on the Richter scale, hit Southern
California centered in the area of Northridge. Total damage has been
estimated at $20 billion. Significant federal aid has been received.
Legislative Due to the Funds' concentration in California state and its
municipal issuers, the Funds may be affected by certain amendments to the
California constitution and state statutes which limit the taxing and
spending authority of California governmental entities and may affect their
ability to meet their debt service obligations.
In 1978, California voters approved "Proposition 13" adding Article XIIIA, to
the state constitution which limits ad valorem taxes on real property to 1%
of "full cash value" and restricts the ability of taxing entities to increase
real property taxes. In subsequent actions, the State substantially increased
its expenditures to provide assistance to its local governments to offset the
losses in revenues and to maintain essential local services; later the State
phased out most local aid in response to its own fiscal pressures.
Another constitutional amendment, Article XIIIB, was passed by voters in 1979
prohibiting the State from spending revenues beyond its annually adjusted
"appropriations limit". Any revenues exceeding this limit must be returned to
the taxpayers as a revision in the tax rate or fee schedule over the
following two years. Such a refund, in the amount of $1.1 billion, occurred
in fiscal year 1987.
Proposition 218, the "Right to Vote on Taxes Act," was approved by the voters
in 1996. It further restricts the ability of local governments to levy and
collect both existing and future taxes, assessments and fees. In addition to
further limiting the financial flexibility of local governments in the state,
it also increases the possibility of voter determined tax rollbacks and
repeals. The interpretation and application of this proposition will
ultimately be determined by the courts.
An effect of the tax and spending limitations in California has been a broad
scale shift by local governments away from general obligation debt that
requires voter approval and pledging future tax revenues, towards lease
revenue financing that is subject to abatement and does not require voter
approval. Lease backed debt is generally viewed as a less secure form of
borrowing and therefore entails greater credit risk. Local governments also
raise capital through the use of Mello-Roos, 1915 Act, and Tax Increment
Bonds, all of which are generally riskier than general obligation debt as
they often rely on tax revenues to be generated by future development for
their support.
Proposition 98, enacted in 1988, changed the State's method of funding
education for grades below the university level. Under this constitutional
amendment, the schools are guaranteed a minimum share of State General Fund
revenues. The major effect of Proposition 98 has been to restrict the State's
flexibility to respond to fiscal stress.
Future initiatives, if proposed and adopted or future court decisions could
create renewed pressure on California governments and their ability to raise
revenues. The State and its underlying localities have displayed flexibility,
however, in overcoming the negative effects of past initiatives.
Financial The recession of the early 1990's placed California's finances
under pressure. From 1991 through 1995, accumulated deficits were carried
over into the following years and the State's general obligation bonds were
downgraded from AAA to A.
Reflecting the recent trend of economic recovery, the state's financial
condition has improved considerably. Fiscal 1998 is expected to close with a
reserve balance of $2.0 billion. Much of this cushion is the result of
explosive growth in capital gains tax collections triggered by a federal tax
rate cut. The Governor has proposed a budget for fiscal 1999 which features
continued growth in capital gains tax collections, offset by a cut in the
vehicle license fee. The State's reserve is projected to be $1.6 billion at
the end of fiscal 1999 (2.8% of revenues.) This reserve will be dedicated to
balance the ongoing costs of reductions in the vehicle license
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fee. We are unable to predict the outcome of the budget package. As of June
1, 1998, the State's general obligation bonds are rated A1 by Moody's, A+ by
S&P, and AA- by Fitch. The consequences of the State's fiscal actions reach
beyond its own general obligation bond ratings. Many state agencies and local
governments which depend upon state appropriations realized significant
cutbacks in funding during the last recession. Entities which have been
forced to make program reductions or to increase fees or raise special taxes
to cover their debt service and lease obligations may recover somewhat during
periods of economic prosperity.
On December 6, 1994, Orange County filed for protection under Chapter 9 of
the U.S. Bankruptcy Code after reports of significant losses in its
investment pool. Upon restructuring, the realized losses in the pool were
$1.6 billion or 21% of assets. More than 200 public entities, most of which,
but not all, are located in Orange County were also depositors in the pool.
The County defaulted on a number of its debt obligations. The County emerged
from bankruptcy on June 12, 1996. Through a series of long-term financings,
it repaid most of its obligations to pool depositors and has become current
on its public debt obligations. The balance of claims against the County are
payable from any proceeds received from litigation against securities dealers
and other parties. The County's ratings were restored to investment grade in
1998.
Sectors Certain areas of potential investment concentration present unique
risks. In 1997, $1.9 billion of tax-exempt debt issued in California was for
public or nonprofit hospitals. A significant portion of the Funds' assets may
be invested in health care issues. For over a decade, the hospital industry
has been under significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial health of many
hospitals. All hospitals are dependent on third-party reimbursement sources
such as the federal Medicare and state MediCal programs or private insurers.
To the extent these third party payers reduce reimbursement levels, the
individual hospitals may be affected. In the face of these pressures, the
trend of hospital mergers and acquisitions has accelerated in recent years.
These organizational changes present both risks and opportunities for the
institutions involved.
The Funds may from time to time invest in electric revenue issues. The
financial performance of these utilities may be impacted as the industry
moves toward deregulation and increased competition. California's electric
utility restructuring plan, Assembly Bill 1890, permits direct competition to
be phased in between 1998 and 2002. Municipal utilities, while not subject to
the legislation, are being faced with competitive market forces and must use
the transition period wisely to proactively prepare for deregulation. They
are under pressure to reduce rates and cut costs in order to maintain their
customer bases. In addition, some electric revenue issues have exposure to or
participate in nuclear power plants which could affect the issuer's financial
performance. Risks include unexpected outages or plant shutdowns, increased
Nuclear Regulatory Commission surveillance or inadequate rate relief.
The Funds may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through various governmental conduits,
are backed solely by the revenues pledged by the respective borrower
corporations. No governmental support is implied.
RISK FACTORS ASSOCIATED WITH A FLORIDA PORTFOLIO
The Fund's program of investing primarily in insured, AAA-rated Florida
municipal bonds should significantly lessen the credit risks which would be
associated with a portfolio of uninsured Florida bonds. Nevertheless, to a
certain degree, the Fund's concentration in securities issued by the State of
Florida and its political subdivisions involves greater risk than a fund
broadly invested in insured bonds across many states and municipalities. The
credit quality of the Fund will depend upon the continued financial strength
of the insurance companies insuring the bonds purchased by the Fund as well
as the State of Florida and the numerous public bodies, municipalities and
other issuers of debt securities in Florida.
Debt The State of Florida and its local governments issue three basic types
of debt, with varying degrees of credit risk: general obligation bonds backed
by the unlimited taxing power of the issuer, revenue bonds secured by
specific pledged funds or charges for a related project, and tax-exempt lease
obligations,
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supported by annual appropriations from the issuer, usually with no implied
tax or specific revenue pledge. During 1997, $10.2 billion in state and local
debt was issued in Florida, a 17% increase from the previous year. Of this
total debt amount, approximately 14% represented general obligation debt and
86% represented revenue bonds and lease-backed obligations. Debt issued in
1997 was for a wide variety of public purposes, including transportation,
housing, education, health care, and utilities.
As of May 10, 1998, the State of Florida had $9.2 billion outstanding general
obligation bonds secured by the State's full faith and credit and taxing
power. General bonded debt service accounted for a modest 2.4% of all
governmental expenditures in fiscal year 1997. An additional $4 billion in
outstanding bonds have been issued by the State and secured by limited state
tax and revenue sources. General obligation debt of the State of Florida is
rated Aa2 by Moody's, AA+ by S&P, and AA by Fitch as of June 1, 1998. State
debt may only be used to fund capital outlay projects; Florida is not
authorized to issue obligations to fund operations.
Several agencies of the State are also authorized to issue debt which does
not represent a pledge of the state's credit. The Florida Housing Finance
Authority and Florida Board of Regents are the largest issuers of this type.
The principal and interest on bonds issued by these bodies are payable solely
from specified sources such as mortgage repayments and university tuition and
fees.
Economy The State of Florida has a population of approximately 14.4 million,
making it the fourth largest state. Due to immigration, the State's
population has grown at a rate exceeding the nation for four decades.
Florida's economy is broadly based with a large concentration in the service
and trade sectors. Tourism is one of Florida's most important industries.
Rebounding from a decline in 1994, visitor traffic grew by 5.6% in 1996 and
reached an all-time high of 43.2 million visitors in 1997.
During most of the 1980s, as Florida's population and employment base grew,
its job growth rate was double that of the nation. However, beginning in
1988, job growth slowed and unemployment rates began trending above national
levels for a number of years. During 1995, Florida's unemployment rate was
8.2% versus 7.4% nationally. Florida's rapid non-farm job growth since 1996
has reversed this trend and the state's February 1998 unemployment rate
stands at 4.8% versus the national average of 4.9%. State per capita income
is 99% of the national average, well above norms for the Southeast.
Legislative The State of Florida does not have a personal income tax. A
constitutional amendment would be required in order to implement such a tax.
Although the probability appears very low, the Fund cannot rule out the
possibility that a personal income tax may be implemented at some time in the
future. If such a tax were to be imposed, there is no assurance that interest
earned on Florida Municipal Obligations would be exempt from this tax.
Under current Florida law, shares of the Fund will be exempt from the State's
intangible personal property tax to the extent that on the annual assessment
date (January 1) its assets are solely invested in Florida Municipal
Obligations and U.S. government securities, certain short-term cash
investments, or other exempt securities. There can be no assurance that this
exemption for Florida securities will be maintained. Also, the
constitutionality of the intangibles tax has been challenged in court.
The Florida Constitution limits the total ad valorem property tax that may be
levied by each county, municipality and school district to ten mills (1.0% of
value). The limit applies only to taxes levied for operating purposes and
excludes taxes levied for the payment of bonds. This restricts the operating
flexibility of local governments in the State and may result from time to
time in budget deficits for some local units.
Financial The Florida Constitution and Statutes mandate that the State budget
as a whole, and each separate fund within the State budget, be kept in
balance from currently available revenues each State fiscal year (July 1-June
30.) The Governor and Comptroller are responsible for insuring that
sufficient revenues are collected to meet appropriations and that no deficit
occurs in any State fund.
The State's revenue structure is narrowly based, relying on the sales and use
tax for 70% of its general revenues. This structure, combined with the
effects of the recession and heavy spending demands, created budget
shortfalls in fiscal years 1991 and 1992. Through midyear spending
adjustments and a draw upon its reserves, the State was able to achieve
budget balance for both fiscal years. The State's finances received a
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substantial boost in fiscal 1993 as a result of increased economic activity
associated with rebuilding efforts after Hurricane Andrew, which hit south
Florida on August 24, 1992. Additionally, Florida recently settled a lawsuit
with the tobacco industry where the state sought to recover the costs
associated with tobacco usage by Floridians. This settlement resulted in a
$750 million payment to the state in 1997 and future payments that will
accumulate to about $10.5 billion over the next 25 years. At the end of 1997,
the State had reserves of $1.2 billion in the General Revenue Fund (7.8% of
revenues).
In November 1994, State voters passed a proposal to limit State revenue
growth to the average annual growth in personal income over the previous five
years. The cap excludes revenue to pay certain expenditures, including debt
service. The limitation should not pose an onerous burden on State finance.
However, the demand for governmental services continues to grow because of
above-average population growth and demographics.
Sectors Certain areas of potential investment concentration present unique
risks. In 1997, $1.3 billion of tax-exempt debt issued in Florida was for
public or nonprofit hospitals. A significant portion of the Fund's assets may
be invested in health care issues.
For over a decade, the hospital industry has been under significant pressure
to reduce expenses and shorten length of stay, a phenomenon which has
negatively affected the financial health of many hospitals. All hospitals are
dependent on third-party reimbursement sources such as the federal Medicare
and state Medicaid programs or private insurers. To the extent these payors
reduce reimbursement levels, the individual hospitals may be affected. In the
face of these pressures, the trend of hospital mergers and acquisitions has
accelerated in recent years. These organizational changes present both risks
and opportunities for the institutions involved. Due to the high proportion
of elderly residents, Florida hospitals tend to be highly dependent on
Medicare. In addition to the regulations imposed by Medicare, the State also
regulates healthcare. A State board must approve the budgets of all Florida
hospitals; certificates of need are required for all significant capital
expenditures. The primary management objective is cost control. The inability
of some hospitals to achieve adequate cost control while operating in a
competitive environment has led to a number of hospital bond defaults.
The Fund may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include unexpected outages or
plant shutdowns, increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance of electric
utilities may be impacted by increased competition and deregulation in the
electric utility industry.
The Fund may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues, sold through various governmental
conduits, are backed solely by the revenues pledged by the respective
borrowing corporations. No government support is implied.
RISK FACTORS ASSOCIATED WITH A GEORGIA PORTFOLIO
The Fund's concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition
to State of Georgia general obligations and state agency issues, the Fund
will invest in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each security's own
structure and underlying economics.
Debt The State of Georgia and its local governments issued $4.6 billion in
municipal bonds in 1997, a 29% increase from the previous year. Of this total
debt amount, approximately 29% was general obligation debt backed by the
unlimited taxing power of the issuer and 71% was revenue bond debt secured by
specific pledged fees or charges for an enterprise or project. As of June 1,
1998, the State was rated Aaa by Moody's, AAA by S&P and AAA by Fitch.
The State of Georgia currently has net direct obligations of approximately
$4.8 billion. Since 1973, when a Constitutional Amendment authorizing the
issuance of state general obligation (GO) bonds was implemented,
<PAGE>
the State has funded most of its capital needs through the issuance of GO
bonds. Previously, capital requirements were funded through the issuance of
bonds by 10 separate authorities and secured by lease rental agreements and
annual state appropriations. Its Constitution permits the State to issue
bonds for two types of public purposes: (1) general obligation debt and (2)
guaranteed revenue debt. The Constitution imposes certain debt limits and
controls. GO debt service cannot exceed 10% of total revenue receipts less
refunds of the state treasury. GO bonds have a maximum maturity of 25 years.
Currently, maximum GO debt service requirements are well below the legal
limit at 5.3% of Fiscal Year 1997 treasury receipts.
In addition to the general obligation and lease backed debt described above,
$301 million bonds have been issued and are outstanding by the Georgia World
Congress Authority and $754 million bonds have been issued and are
outstanding by the Georgia Housing and Finance Authority, none of which
represent direct obligations of the State.
Economy The State of Georgia has a population of approximately 7.4 million,
making it the 10th largest state. Since the 1960s, the State's population has
grown at a rate exceeding the national average, with the growth rate during
the 1980s nearly twice that of the entire country. Stable to strong economic
growth during the 1980s was led by the Atlanta metropolitan statistical area,
where approximately 45% of the State's population is located. This area
includes the capital city of Atlanta, and 18 surrounding counties. The next
largest metropolitan area is the Columbus-Muscogee area followed by the Macon
area.
The State's economy is well diversified. The current labor force of 3.7
million is largely concentrated in service and wholesale/retail trade jobs,
followed by lesser amounts in manufacturing and government. Employment gains
have substantially exceeded the region and the U.S. since 1980. Georgia's one
year employment growth (February 1997 to February 1998) stood at 3.8%
compared to the national rate of 2.9%. The State's economy continues to
outperform the nation, despite a slowing after the high level of economic
activity resulting from the 1996 Olympic Games. Georgia's per capita income
has steadily improved against the national average since the 1960s and
currently is 94% of the U.S., ranking it 25th among the states.
Financial To a large degree, the creditworthiness of the portfolio is
dependent on the financial strength of the State of Georgia and its
localities. During the 1980s, the State's strong economic performance
translated into solid financial performance and the accumulation of
substantial reserves.
During fiscal 1989 to 1991, the State's financial condition was affected by
three years of revenue shortfalls brought on by recession. During these
periods, the Governor called special legislative sessions to enact sizable
spending cuts to achieve budget balance. Economic conditions improved in
1992, allowing the State to restore its financial cushion. Results for fiscal
1997 showed a continuation of this positive trend with an ending unreserved
general fund balance of $969 million, or 8% of revenues.
A significant portion of the portfolio's assets is expected to be invested in
the debt obligations of local governments and public authorities with
investment grade ratings of BBB or higher. While local governments in Georgia
are primarily reliant on independent revenue sources, such as property taxes,
they are not immune to budget shortfalls caused by cutbacks in State aid. The
Fund may purchase obligations issued by public authorities in Georgia which
are not backed by the full faith and credit of the State and may or may not
be subject to annual appropriations from the State's General Fund. Likewise,
certain enterprises such as water and sewer systems or hospitals may be
affected by changes in economic activity.
Sectors Certain areas of potential investment concentration present unique
risks. In 1997, $276 million of tax-exempt debt issued in Georgia was for
public or nonprofit hospitals. A significant portion of the Fund's assets may
be invested in health care issues. For over a decade, the hospital industry
has been under significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial health of many
hospitals. All hospitals are dependent on third-party reimbursement sources
such as the federal Medicare and state Medicaid programs or private insurers.
To the extent these payors reduce reimbursement levels, the individual
hospitals may be affected. In the face of these pressures, the trend of
hospital mergers and acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for the
institutions involved.
<PAGE>
The Fund may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include unexpected outages or
plant shutdowns, increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance of electric
utilities may be impacted by increased competition and deregulation of the
electric utility industry.
The Fund may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through various governmental conduits,
are backed solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied.
RISK FACTORS ASSOCIATED WITH A MARYLAND PORTFOLIO
Each Fund's concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition
to State of Maryland general obligations and state agency issues, the Fund
will invest in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each security's own
structure and underlying economics.
Debt The State of Maryland and its local governments issue three basic types
of debt, with varying degrees of credit risk: general obligation bonds backed
by the unlimited taxing power of the issuer, revenue bonds secured by
specific pledged fees or charges for a related project, and tax-exempt lease
obligations, secured by annual appropriations by the issuer, usually with no
implied tax or specific revenue appropriations by the issuer. In 1997, $2.8
billion in state and local debt was issued in Maryland, with approximately
41% representing general obligation debt and 59% revenue bonds and
lease-backed debt.
The State of Maryland had $3.0 billion in general obligation bonds
outstanding as of December 31, 1997 along with an additional $1.3 billion in
other tax-supported debt. General obligation debt of the State of Maryland is
rated Triple-A by Moody's, S&P, and Fitch. There is no general debt limit
imposed by the State Constitution or public general laws. The State
Constitution imposes a 15-year maturity limit on State general obligation
bonds. Although voters approved a constitutional amendment in 1982 permitting
the State to borrow up to $100 million in short-term notes in anticipation of
taxes and revenues, the State has not made use of this authority.
Many agencies and other instrumentalities of the State government are
authorized to borrow money under legislation which expressly provides that
the loan obligations shall not be deemed to constitute a debt or a pledge of
the faith and credit of the State. The Community Development Administration
of the Department of Housing and Community Development, the Maryland Stadium
Authority, the Board of Trustees of St. Mary's College of Maryland, the
Maryland Environmental Service, the Board of Regents of the University of
Maryland System, the Board of Regents of Morgan State University, the
Maryland Food Center Authority, and the Maryland Water Quality Financing
Administration have issued and have outstanding bonds of this type. The
principal of and interest on bonds issued by these bodies are payable solely
from pledged revenues, principally fees generated from use of the facilities,
enterprises financed by the bonds, or other dedicated fees.
Economy The economy of the State of Maryland generally demonstrates strong
performance relative to the nation. Per capita income is 13% above the U.S.
average. Unemployment in March of 1998 was 4.6%, compared to a national
average of 4.7%. The State's population in 1997 was 5 million, with 87%
concentrated in the Baltimore-Washington corridor.
Financial To a large degree, the risk of the Funds is dependent upon the
financial strength of the State of Maryland and its localities. Over the long
term, Maryland's financial condition has been strong; however, in fiscal
1992, the State experienced unanticipated shortfalls in revenues, as
collections of major taxes fell during the recession. To address this loss,
the governor enacted a series of midyear reductions in expenditures,
primarily cuts in local aid.
Balancing the state budget for fiscal year 1993 involved a variety of
additional taxes, including a higher income tax on upper income households
and an expanded sales tax. The legislature also adopted further cuts
<PAGE>
in State aid to localities, but this action was offset by the ability of
localities to increase the local "piggyback" tax from 50 percent to 60
percent of the State rate. These actions were successful in restoring the
State's financial condition and replenishing reserves. In fiscal 1994
Maryland's economy began to improve, allowing the state to continue to
strengthen its financial condition. The results of fiscal year 1998 are
projected to show a general fund balance of $318 million and a Budget
Stabilization Account balance of $616 million, together representing 11.4% of
expenditures. The fiscal 1999 incorporates the first full year of a 10%
reduction in the personal income tax rate, to be phased in over five years.
Funding the final years of this plan is expected to require a draw down of
the reserve position.
Many local Maryland governments also suffered from fiscal stress and general
declines in financial performance during the last recession. Downturns in
real estate related receipts, declines in the growth of income tax revenues,
lower cash positions and reduced interest income were common problems. State
aid to local governments was also reduced during that period. Local
governments closed these gaps by increasing property and local income tax
rates, implementing program cuts, and curtailing pay raises. Certain counties
in Maryland are subject to voter approval limitations on property tax levy
increases or on governmental spending which limits their flexibility in
responding to external changes.
Future voter initiatives, if proposed and adopted, could create pressure on
the counties and other local governments and their ability to raise revenues.
The Funds cannot predict the impact of any such future tax limitations on
debt quality.
Sectors Certain areas of potential investment concentration present unique
risks. In 1997, $767 million of tax-exempt debt issued in Maryland was for
public or nonprofit hospitals. A significant portion of the Funds' assets may
be invested in health care issues. For over a decade, the hospital industry
has been under significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial health of some
hospitals. All hospitals are dependent on third party reimbursement
mechanisms. At the present time Maryland hospitals operate under a system
which reimburses hospitals according to a State administered set of rates and
charges for all payers rather than the Federal Diagnosis Related Group
(DRG's) system which applies to Medicare payments. Since 1983, Maryland
hospitals, on average over the trailing three-year period, have increased
hospital charges at a level below the national average in terms of Medicare
cost increases, allowing them to continue operating under a Medicare waiver.
Any loss of this waiver in the future may have an adverse impact upon the
credit quality of Maryland hospitals.
The Funds may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include unexpected outages or
plant shutdowns, increased Nuclear Regulatory Commission surveillance or
inadequate rate relief. In addition, the financial performance of electric
utilities may be impacted by increased competition and deregulation in the
industry.
The Funds may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through various governmental conduits,
are backed solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied.
RISK FACTORS ASSOCIATED WITH A NEW JERSEY PORTFOLIO
The Fund's concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition
to State of New Jersey general obligation bonds, notes and state agency
issues, the Fund will invest in local bond issues, lease obligations and
revenue bonds, the credit quality and risk of which will vary according to
each security's own structure and underlying economics.
Debt The State of New Jersey and its local governments issued $9.0 billion of
municipal bonds in 1997. Of this amount, approximately 29% was general
obligation debt backed by the unlimited taxing power of the issuer and 71%
were revenue bonds secured by specific pledged fees or charges for an
enterprise or project.
<PAGE>
Included within the revenue bond sector are tax-exempt lease obligations that
are subject to annual appropriations of a governmental body, usually with no
implied tax or specific revenue pledge. Debt issued in 1997 was for a wide
array of public purposes, including water and sewer projects, health care,
housing, education, transportation, and pollution control.
The State of New Jersey has approximately $3.4 billion outstanding general
obligation bonds secured by the State's revenue and taxing power. As of June
1, 1998, its general obligation bonds were rated Aa1 by Moody's, AA+ by S&P
and AA+ by Fitch. In addition to the State's direct debt, it is obligated for
certain lease-backed debt issued through the Mercer County Improvement
Authority, the New Jersey Economic Development Authority, the New Jersey
Building Authority, the Educational Facilities Authority and the
Transportation Trust Fund Authority. Under State law, the obligations of
certain local school districts and county college districts have been
supported by State appropriations. The State has also entered into a "moral
obligation" (as opposed to a legal commitment) to make up debt service
shortfalls for the New Jersey Housing and Mortgage Finance Agency as well as
the South Jersey Port Corporation. While no assistance has ever been required
for the New Jersey Housing and Mortgage Finance Agency, from time to time,
the State has supported the operations and debt service of the South Jersey
Port Corporation. The State has also guaranteed bonds issued by the Sports
and Exposition Authority. The related obligations of the State described in
this paragraph total an additional $9.0 billion.
A number of other state-created agencies issue tax-exempt revenue bonds that
are not a debt or liability of the State. The largest such entities include
the New Jersey Turnpike Authority, the New Jersey Educational Facilities
Authority and the New Jersey Health Care Facilities Financing Authority.
A significant portion of the portfolio's assets is expected to be invested in
the debt obligations of local governments and public authorities with
investment grade ratings of BBB or higher. While local governments in New
Jersey are primarily reliant on independent revenue sources, such as property
taxes, they are not immune to budget shortfalls caused by economic downturns
or cutbacks in State aid. Likewise, certain enterprises such as toll roads or
hospitals may be affected by changes in economic activity. Under the New
Jersey Local Budget Law, the State oversees the budget preparation of local
governments and has certain powers to enforce balanced budgets, limit short
term borrowing and regulate overall debt limits.
Economy New Jersey is the ninth largest and most densely populated state with
7.9 million residents. The economic base is diversified among manufacturing,
construction, services, and agricultural uses. The per capita personal income
of $32,654 ranks the State as the second highest in the United States. Over
the long term, the State's economy has been a strong performer, with
unemployment levels generally below national averages; however, since the
recession of 1991-92, the State's growth rate has lagged the nation.
Financial To a large degree, the risk of the portfolio is dependent on the
financial strength of the State of New Jersey and its localities.
Characteristically, the State has demonstrated solid financial performance,
but operations suffered as the State's economy stagnated during the recession
of the early 1990's. In fiscal 1990 through 1994 New Jersey utilized
non-recurring revenues and expenditure deferrals and a tax increase to
achieve balance. An environment of cost controls and a slightly improved
economy allowed the State to conclude fiscal year 1997 with an unreserved
general fund balance of $870 million (5.3% of general revenues). Effective
January 1996, the State completed the last stage of a 30% reduction in
personal income tax rates which was accommodated for in the budget for fiscal
year 1997. The budget for fiscal 1998 is expected to end with a large
surplus, reflecting an improving economy and cost control.
Sectors Certain areas of potential investment concentration present unique
risks. In 1996, 10.8% of tax-exempt debt issued in New Jersey was for public
or nonprofit hospitals. A significant portion of the Fund's assets may be
invested in health care issues. For over a decade, the hospital industry has
been under significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial health of many
hospitals. While each hospital bond issue is separately secured by the
individual hospital's revenues, third-party reimbursement sources such as the
federal Medicare and state Medicaid programs or private insurers are common
to all hospitals. To the extent these payors reduce reimbursement levels, the
individual hospitals may be affected. In the face of these pressures, the
trend of
<PAGE>
hospital mergers and a acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for the
institutions involved. In late 1997, the State of New Jersey reauthorized the
funding of charity care subsidies to eligible hospitals. The failure of the
State to renew this program or put in place a permanent funding mechanism may
affect the financial performance of certain New Jersey hospitals in future
years.
The Fund may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include delay in construction and
operation due to increased regulation, unexpected outages or plant shutdowns,
increased Nuclear Regulatory Commission surveillance or inadequate rate
relief. In addition, the financial performance of electric utilities may be
impacted by increased competition and deregulation in the industry.
The Fund may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through governmental conduits, such as
the New Jersey Economic Development Authority and various local issuers, are
backed solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied. This category accounted for
5.6% of the tax-exempt debt issued in New Jersey during 1996. In the past, a
number of New Jersey Economic Development Authority issues have defaulted as
a result of borrower financial difficulties. A number of counties and utility
authorities in the state have issued several billion dollars of bonds to fund
incinerator projects and solid waste projects. A federal court decision
striking down New Jersey's system of solid waste flow control increases the
potential risk of default absent a legislative solution, or some form of
subsidy by local or State governments.
RISK FACTORS ASSOCIATED WITH A NEW YORK PORTFOLIO
The Funds' concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition
to state general obligation bonds and notes and the debt of various state
agencies, the Fund will invest in local bond issues, lease obligations and
revenue bonds, the credit quality and risk of which will vary according to
each security's own structure and underlying economics.
The Funds' ability to maintain a high level of "triple-exempt" income is
primarily dependent upon the ability of New York issuers to continue to meet
debt service obligations in a timely fashion. In 1975 the State, New York
City, and other related issuers experienced serious financial difficulties
that ultimately resulted in much lower credit ratings and loss of access to
the public debt markets. A series of fiscal reforms and an improved economic
climate allowed these entities to return to financial stability by the early
1980s. Credit ratings were reinstated or raised and access to the public
credit markets was restored. During the early 1990s, the State and City
confronted renewed fiscal pressure, as the region suffered moderate economic
decline. Conditions began to improve in 1993, though below average economic
performance and tight budgetary conditions persisted. Both entities
experienced financial relief in fiscal 1997 because of the strong national
economy, a robust financial services sector, and vigilant spending control.
The State and City continue to face challenging budgets while they attempt to
adjust spending levels and priorities.
New York State
The State, its agencies, and local governments issued $27.9 billion in
long-term municipal bonds in 1997, a 31% increase from the previous year. As
of March 31, 1998, total State-related bonded debt was projected to be $33.7
billion, of which $5.0 billion was general obligation debt and $28.7 billion
was financed under lease-purchase or other contractual obligations. In
addition, the State had $293 million in bond anticipation notes outstanding.
Since 1993, the State has not issued Tax and Revenue Anticipation Notes
(TRANs) terminating the practice of annual seasonal borrowing which had
occurred since 1952. As of June 1, 1998, the State's general obligation bonds
were rated A2 by Moody's, A by S&P and A+ by Fitch. All general obligation
bonds must be approved by the voters prior to issuance.
<PAGE>
The fiscal stability of the State is also important for numerous authorities
which have responsibilities for financing, constructing, and operating
revenue-producing public benefit facilities. As of September 30, 1995, there
were 17 authorities that had aggregate debt outstanding, including refunding
bonds, of $73 billion.
The authorities most reliant upon annual direct State support include the
Metropolitan Transit Authority (MTA), the Urban Development Authority (UDC),
and the New York Housing Finance Agency (HFA). In February 1975, the UDC
defaulted on approximately $1.0 billion of short-term notes. The default was
ultimately cured by the creation of the Project Finance Authority (PFA),
through which the State provided assistance to the UDC, including support for
debt service. Since then, there have been no additional defaults by State
authorities although substantial annual assistance is required by the MTA and
the HFA in particular.
Subsequent to the fiscal crisis of the mid-70s, New York State maintained
balanced operations on a cash basis, although by 1992 it had built up an
accumulated general fund deficit of over $6 billion on a "Generally Accepted
Accounting Principles" (GAAP) basis. This deficit consisted mainly of overdue
tax refunds and payments due localities.
To resolve its accumulated general fund deficit the State established the
Local Government Assistance Corporation (LGAC) in 1990. A total of $5.2
billion in LGAC bonds have been issued. The proceeds of these bonds were used
to provide the State's assistance to localities and school districts,
enabling the State to reduce its accumulated general fund deficit. State
short-term borrowing requirements, which peaked at a record $5.9 billion in
fiscal 1991, have been reduced to zero. Nonetheless, the State ended fiscal
1997 with a General Fund unreserved deficit balance of $1.7 billion. The
adopted budget for fiscal 1996 included a multi-year tax reduction plan which
lowers the maximum personal income tax rate from 7.875 to 6.85%. The original
budget proposal for the fiscal year ended March 31,1997, included a
multi-year personal income tax rate cut and emphasized cost control to
balance against the effects of a weak economy. Because of strong growth in
personal income and business taxes, fiscal year 1997 ended with an operating
surplus of $1.9 billion, which will helped smooth budget balancing efforts
for fiscal year 1998. Fiscal year 1998 is estimated to have ended with
another large operating surplus.
New York State has a large, diversified economy which has witnessed a basic
shift away from manufacturing toward service sector employment. In 1997, per
capita income in New York State was $30,752, 20% above the national average.
Like most northeastern states, New York suffered a population loss during the
1970s. However, during the 1980s that trend reversed and population increased
slightly, standing at 18,137,000 in 1997. During 1990-1992, the State
experienced a slowing of economic growth evidenced by the loss of 425,000
jobs. Conditions have improved with non-farm employment growing by an average
of 0.9% between 1994 and 1997, well below the national average. Such economic
trends are important as they influence the growth or contraction of State
revenues available for operations and debt service.
New York City
The financial problems of New York City were acute between 1975 and 1979,
highlighted by a payment moratorium on the City's short-term obligations. In
the subsequent decade, the City made a significant recovery. The most
important contribution to the City's fiscal recovery was the creation of the
Municipal Assistance Corporation for the City of New York (MAC). Backed by
sales, use, stock transfer, and other taxes, MAC issued bonds and used the
proceeds to purchase City bonds and notes. Although the MAC bonds met with
reluctance by investors at first, the program has proven to be very
successful.
Much progress has been made since the fiscal crisis of 1975. By 1981, the
City achieved a budget balanced in accordance with Generally Accepted
Accounting Principles (GAAP) and has continued to generate small surpluses on
an operating basis. By 1983, the City eliminated its accumulated General Fund
deficit and as of the fiscal year ending June 30, 1997, had a total General
Fund balance of $373 million. Although the City continues to finance its
seasonal cash flow needs through public borrowings, the total amount of these
borrowings has not exceeded 10% of any year's revenues and all have been
repaid by the end of the fiscal year.
As of June 1, 1997 the City's general obligation bonds are rated A3 by
Moody's, BBB+ by S&P and A- by Fitch. S&P has listed the City's rating on
positive credit watch.
<PAGE>
While New York City sustained a decade long record of relative financial
stability, during the 1990s budgetary pressures have been evident. Its major
revenue sources, income and sales taxes, were slowed and a downturn in the
real estate market reduced property tax revenues. Nonetheless, the City
concluded the 1997 fiscal year with an operating surplus of $1.3 billion. The
City's finances have been bolstered by strong tax receipts growth, fueled by
strong financial markets over the last several years. Revenues and
expenditures for the 1997 fiscal year were balanced in accordance with GAAP
for the seventeenth consecutive year. New York City remains exposed to future
budget pressure should there be a sharp down turn in the financial services
sector, though it has established a budget stabilization account for
contingency.
Long Island and LILCO
The Long Island Lighting Company (LILCO) was the single largest property
taxpayer in both Nassau and Suffolk Counties. LILCO experienced substantial
financial difficulty primarily arising from problems related to its completed
but unlicensed 809 megawatt Shoreham Nuclear Power Facility located in
Suffolk County. In 1986, the State Legislature created the Long Island Power
Authority (LIPA) and ownership of the Shoreham Plant was subsequently
transferred to LIPA for one dollar in exchange for certain rate benefits to
LILCO.
As requested by the Governor, LIPA proposed a plan to restructure LILCO,
reduce rates on Long Island and provide a framework for long-term competition
in power production. Included in the plan would be a settlement of the
Suffolk County tax liability. With the issuance of $7 billion in debt, LIPA
will purchase LILCO common stock, acquire or redeem certain preferred stock
and outstanding debt, and fund the cost of certain rebates and credits to
LIPA's customers. With these purchases, LIPA would acquire LILCO's electric
transmission and distribution system, its 18% ownership interest in the Nine
Mile Point 2 nuclear plant and the regulatory asset of Shoreham. In May 1998,
LIPA sold its first two series of bonds amounting to $4.9 billion. This
allowed for the acquisition of LILCO by LIPA and a merger of the remaining
portions of the former LILCO business with Keyspan Energy to form Marketspan
Corp. LIPA will now be the provider of retail electric service throughout
most of Long Island.
Sectors Certain areas of potential investment concentration present unique
risks. In 1997, $1.9 billion of tax-exempt debt issued in New York was for
public or nonprofit hospitals. A significant portion of the Fund's assets may
be invested in health care issues. For over a decade, the hospital industry
has been under significant pressure to reduce expenses and shorten length of
stay, a phenomenon which has negatively affected the financial health of many
hospitals. While each hospital bond issue is separately secured by the
individual hospital's revenues, third-party reimbursement sources such as the
federal Medicare and state Medicaid programs or private insurers are common
to all hospitals. To the extent these third-party payors reduce reimbursement
levels, the individual hospitals may be affected. The state's support for
Medicaid and health services has slowed over the last several years. In 1997
health care reform was implemented. Under the new system, hospitals are
permitted to negotiate inpatient payment rates with private payors. In
addition, the federal balanced budget act of 1997 contains provisions to
reduce Medicare expenditures. In the face of these pressures, the trend of
hospital mergers and acquisitions has accelerated in recent years. These
organizational changes present both risks and opportunities for the
institutions.
The Funds may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include unexpected outages or plan
shutdowns, increased Nuclear Regulatory Commission surveillance or inadequate
rate relief. In addition, the financial performance of electric utilities may
be impacted by increased competition and deregulation in the industry.
The Funds may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through various governmental conduits,
are backed solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied. This category accounted for
9.8% of the tax-exempt debt issued in New York during 1997.
<PAGE>
RISK FACTORS ASSOCIATED WITH A VIRGINIA PORTFOLIO
The Funds' concentration in the debt obligations of one state carries a
higher risk than a portfolio that is geographically diversified. In addition
to State of Virginia general obligations and state agency issues, the Fund
will invest in local bond issues, lease obligations and revenue bonds, the
credit quality and risk of which will vary according to each security's own
structure and underlying economics.
Debt The State of Virginia and its local governments issued $3.8 billion
municipal bonds in 1997, including general obligation debt backed by the
unlimited taxing power of the issuer and revenue bonds secured by specific
pledged fees or charges for an enterprise or project. Included within the
revenue bond category are tax-exempt lease obligations that are subject to
annual appropriations of a governmental body to meet debt service, usually
with no implied tax or specific revenue pledge. Debt issued in 1997 was for a
wide variety of public purposes, including transportation, housing,
education, health care, and industrial development.
As of June 30, 1997, the State of Virginia had $1.1 billion outstanding
general obligation bonds secured by the State's revenue and taxing power, a
modest amount compared to many other states. Under state law, general
obligation debt is limited to 1.15 times the average of the preceding three
years' income tax and sales and use tax collections. The State's outstanding
general obligation debt is well below that limit and over 90% of the debt
service is actually met from revenue producing capital projects such as
universities and toll roads.
The State also supports $1.9 billion in debt issued by the Virginia Public
Building Authority, the Virginia College Building Authority, the Virginia
Port Authority, the Innovative Technology Authority and for transportation
purposes. These bonds are not backed by the full faith and credit of the
State but instead, are subject to annual appropriations from the State's
General Fund.
In addition to the State and public authorities described above, an
additional $7.3 billion bonds have been issued by special public authorities
in Virginia that are not obligations of the State. These bonds include debt
issued by the Virginia Education Loan Authority, the Virginia Public School
Authority, the Virginia Resources Authority, and the Virginia Housing
Development Authority.
Economy The State of Virginia has a population of approximately 6.7 million,
making it the twelfth largest state. Since the 1930s the State's population
has grown at a rate near or exceeding the national average. Stable to strong
economic growth during the 1980s was led by the northern Virginia area
outside of Washington, D.C. where approximately 25% of the State's population
is concentrated. The next largest metropolitan area is the Norfolk-Virginia
Beach-Newport News area, followed by the Richmond-Petersburg area, including
the State's capital of Richmond. The State's economy is broadly based, with a
large concentration in service and governmental jobs, followed by
manufacturing. Virginia has significant concentrations of high technology
employers, with nearly 150,000 people employed in 3,900 establishments. Per
capita income exceeds national averages while unemployment figures have
consistently tracked below national averages.
Financial To a large degree, the risk of the portfolio is dependent on the
financial strength of the State of Virginia and its localities. As of June 1,
1998, the State was rated Triple-A by Moody's, S&P and Fitch. The State's
budget is prepared on a biennial basis. From 1970 through 1996 the State's
General Fund showed a positive balance for all of its two-year budgetary
periods. The national recession and its negative effects on State personal
income tax collections did, however, force the State to draw down its General
Fund balances to a deficit position in 1992. Spending cuts and improved
economic conditions allowed for positive operations in 1993-1997. The State
posted a budgetary surplus for fiscal years 1995 to 1997 despite federal
retiree settlements and other transfers. On June 30, 1997, the unreserved
general fund balance, including a revenue stabilization account, totaled $435
million.
A significant portion of the Funds' assets is expected to be invested in the
debt obligations of local governments and public authorities with investment
grade ratings of BBB or higher. While local governments in Virginia are
primarily reliant on independent revenue sources, such as property taxes,
they are not immune to budget shortfalls caused by cutbacks in State aid.
Likewise, certain enterprises such as toll roads or hospitals may be affected
by changes in economic activity.
<PAGE>
Sectors Certain areas of potential investment concentration present unique
risks. A significant portion of the Fund's assets may be invested in health
care issues. For over a decade, the hospital industry has been under
significant pressure to reduce expenses and shorten length of stay, a
phenomenon which has negatively affected the financial health of many
hospitals. While each hospital bond issue is separately secured by the
individual hospital's revenues, third-party reimbursement sources such as the
federal Medicare and state Medicaid programs or private insurers are common
to all hospitals. To the extent these payors reduce reimbursement levels, the
individual hospitals may be affected. In the face of these pressures, the
trend of hospital mergers and acquisitions has accelerated in recent years.
These organizational changes present both risks and opportunities for the
institutions involved.
The Funds may from time to time invest in electric revenue issues which have
exposure to or participate in nuclear power plants which could affect the
issuers' financial performance. Such risks include unexpected outages or
plant shutdowns, increased Nuclear Regulatory Commission surveillance or
inadequate rate relief.
The Funds may invest in private activity bond issues for corporate and
nonprofit borrowers. These issues sold through various governmental conduits,
are backed solely by the revenues pledged by the respective borrowing
corporations. No governmental support is implied.
All State Funds
Puerto Rico From time to time the State Funds invest in obligations of the
Commonwealth of Puerto Rico and its public corporations which are exempt from
federal, state and city or local income taxes. The majority of the
Commonwealth's debt is issued by the major public agencies that are
responsible for many of the islands' public functions, such as water,
wastewater, highways, telecommunications, education, and public construction.
As of January 31, 1998, public sector debt issued by the Commonwealth and its
public corporations totaled $20.6 billion.
Since the 1980s, Puerto Rico's economy and financial operations have
paralleled the economic cycles of the United States. The island's economy,
particularly the manufacturing sector, has experienced substantial gains in
employment. Much of these economic gains are attributable in part to
favorable treatment under Section 936 of the Federal Internal Revenue Code
for United States corporations doing business in Puerto Rico. The number of
persons employed in Puerto Rico during fiscal 1997 averaged 1.1 million
persons--a record level. Unemployment, however, still remains high at 13.1
percent.
Debt ratios for the Commonwealth are high as it assumes much of the
responsibility for local infrastructure. Sizable infrastructure programs are
ongoing to upgrade the island's water, sewer, and road systems. The
Commonwealth's general obligation debt is secured by a first lien on all
available revenues. The Commonwealth has maintained a fiscal policy which
seeks to correlate the growth in public sector debt to the growth of the
economic base available to service that debt. Between fiscal years 1993 and
1997, however, debt increased 37% while gross product rose 27.7%. Short term
debt remains a modest 10.6% of total debt outstanding as of January 31, 1998.
The maximum annual debt service requirement on Commonwealth general
obligation debt totals 9.5% of governmental revenues for fiscal 1997. This is
well below the 15% limit imposed by the Constitution of Puerto Rico.
The fiscal year 1994 budget was balanced with an increase in the "tollgate"
tax on Section 936 companies and improved revenue collections, which enabled
the Commonwealth to record a strong turnaround in the General Fund balance to
$309 million (6.8% of general fund expenses). A General Fund balance of $304
million was recorded for the end of fiscal year 1997.
The Commonwealth's economy remains vulnerable to changes in oil prices,
American trade, foreign policy, and levels of federal assistance. Per capita
income levels, while being the highest in the Caribbean, lag far behind the
United States. In November 1993, the voters of Puerto Rico were asked in a
non-binding referendum to consider the options of statehood, continued
Commonwealth status, or independence. 48.4% of the voters favored
continuation of Commonwealth status, 46.2% were for statehood, and 4.4% were
for independence. In 1997 legislation was introduced in Congress proposing a
mechanism to permanently settle the political relationship with the United
States. In March 1998, the U.S. House of Representatives voted in
<PAGE>
favor of a political status act that includes a referendum to be held in 1998
and a 10-year transition plan. It is not certain whether a bill will
eventually be signed into law.
For many years U.S. companies operating in Puerto Rico were eligible to
receive a special tax credit available under Section 936 of the federal tax
code, which helped spur significant expansion in capital intensive
manufacturing activity. Federal tax legislation was passed in 1993 which
revised the tax benefits received by U.S. corporations (Section 936 firms)
that operate manufacturing facilities in Puerto Rico. The legislation
provides these firms with two options: a 5-year phased reduction of the
income based tax credit to 40% of the previously allowable credit or the
conversion to a wage based standard, allowing a tax credit for the first 60%
of qualified compensation paid to employees as defined in the IRS Code.
Studies indicate that there have been no reductions in the economic growth
rate or employment in industries which were expected to be impacted by the
1993 amendments. In 1996, amendments were signed into law to phase out the
tax credit over a 10- year period for existing claimants and to eliminate it
for corporations without established operations after October 1995. At
present, it is difficult to forecast what the short and long term effects of
a phase-out of the Section 936 credit would have on the economy of Puerto
Rico.
A final risk factor with the Commonwealth is the large amount of unfunded
pension liabilities. The two main public pension systems are largely
underfunded. The employees retirement system has an unfunded liability of
$5.5 billion and the teachers retirement system has an unfunded liability of
$1 billion. A measure enacted by the legislature in 1990 is designed to
address the solvency of the plans over a 50-year period.
INVESTMENT PROGRAM
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Types of Securities
Set forth below is additional information about certain of the investments
described in the Fund's prospectus.
Municipal Securities
Subject to the investment objectives and programs described in the prospectus
and the additional investment restrictions described in this Statement of
Additional Information, each Fund's portfolio may consist of any combination
of the various types of municipal securities described below or other types
of municipal securities that may be developed. The amount of each Fund's
assets invested in any particular type of municipal security can be expected
to vary.
The term "municipal securities" means obligations issued by or on behalf of
states, territories, and possessions of the United States and the District of
Columbia and their political subdivisions, agencies and instrumentalities, as
well as certain other persons and entities, the interest from which is exempt
from federal, state, and/or city or local, if applicable, income tax. In
determining the tax-exempt status of a municipal security, the Fund relies on
the opinion of the issuer's bond counsel at the time of the issuance of the
security. However, it is possible this opinion could be overturned, and as a
result, the interest received by the Fund from such a security might not be
exempt from federal income tax.
Municipal securities are classified by maturity as notes, bonds, or
adjustable rate securities.
Municipal Notes
Municipal notes generally are used to provide short-term operating or capital
needs and generally have maturities of one year or less. Municipal notes
include:
. Tax Anticipation Notes Tax anticipation notes are issued to finance working
capital needs of municipalities. Generally, they are issued in anticipation
of various seasonal tax revenue, such as income, property, use and business
taxes, and are payable from these specific future taxes.
. Revenue Anticipation Notes Revenue anticipation notes are issued in
expectation of receipt of other types of revenue, such as federal or state
revenues available under the revenue sharing or grant programs.
<PAGE>
. Bond Anticipation Notes Bond anticipation notes are issued to provide
interim financing until long-term financing can be arranged. In most cases,
the long-term bonds then provide the money for the repayment of the notes.
. Tax-Exempt Commercial Paper Tax-exempt commercial paper is a short-term
obligation with a stated maturity of 270 days or less. It is issued by state
and local governments or their agencies to finance seasonal working capital
need or as short-term financing in anticipation of longer-term financing.
. Municipal Bonds Municipal bonds, which meet longer-term capital needs and
generally have maturities of more than one year when issued, have two
principal classifications: general obligation bonds and revenue bonds. Two
additional categories of potential purchases are lease revenue bonds and
pre-refunded/escrowed to maturity bonds. Another type of municipal bond is
referred to as an Industrial Development Bond.
. General Obligation Bonds Issuers of general obligation bonds include states,
counties, cities, towns, and special districts. The proceeds of these
obligations are used to Fund a wide range of public projects, including
construction or improvement of schools, public buildings, highways and roads,
and general projects not supported by user fees or specifically identified
revenues. The basic security behind general obligation bonds is the issuer's
pledge of its full faith and credit and taxing power for the payment of
principal and interest. The taxes that can be levied for the payment of debt
service may be limited or unlimited as to the rate or amount of special
assessments. In many cases voter approval is required before an issuer may
sell this type of bond.
. Revenue Bonds The principal security for a revenue bond is generally the net
revenues derived from a particular facility, or enterprise, or in some cases,
the proceeds of a special charge or other pledged revenue source. Revenue
bonds are issued to finance a wide variety of capital projects including:
electric, gas, water and sewer systems; highways, bridges, and tunnels; port
and airport facilities; colleges and universities; and hospitals. Revenue
bonds are sometimes used to finance various privately operated facilities
provided they meet certain tests established for tax-exempt status.
Although the principal security behind these bonds may vary, many provide
additional security in the form of a mortgage or debt service reserve Fund.
Some authorities provide further security in the form of the state's ability
(without obligation) to make up deficiencies in the debt service reserve
Fund. Revenue bonds usually do not require prior voter approval before they
may be issued.
. Lease Revenue Bonds Municipal borrowers may also finance capital
improvements or purchases with tax-exempt leases. The security for a lease is
generally the borrower's pledge to make annual appropriations for lease
payments. The lease payment is treated as an operating expense subject to
appropriation risk and not a full faith and credit obligation of the issuer.
Lease revenue bonds are generally considered less secure than a general
obligation or revenue bond and often do not include a debt service reserve
Fund. To the extent the Fund's Board determines such securities are illiquid,
they will be subject to the Fund's limit on illiquid securities. There have
also been certain legal challenges to the use of lease revenue bonds in
various states.
The liquidity of such securities will be determined based on a variety of
factors which may include, among others: (1) the frequency of trades and
quotes for the obligation; (2) the number of dealers willing to purchase or
sell the security and the number of other potential buyers; (3) the
willingness of dealers to undertake to make a market in the security; (4) the
nature of the marketplace trades, including the time needed to dispose of the
security, the method of soliciting offers, and the mechanics of transfer; and
(5) the rating assigned to the obligation by an established rating agency or
T. Rowe Price.
. Pre-refunded/Escrowed to Maturity Bonds Certain municipal bonds have been
refunded with a later bond issue from the same issuer. The proceeds from the
later issue are used to defease the original issue. In many cases the
original issue cannot be redeemed or repaid until the first call date or
original maturity date. In these cases, the refunding bond proceeds typically
are used to buy U.S. Treasury securities that are held in an escrow account
until the original call date or maturity date. The original bonds then become
"pre-refunded" or "escrowed to maturity" and are considered as high-quality
investments. While still tax-exempt, the security is the proceeds of the
escrow account. To the extent permitted by the Securities and Exchange
Commission
<PAGE>
and the Internal Revenue Service, a Fund's investment in such securities
refunded with U.S. Treasury securities will, for purposes of diversification
rules applicable to the Fund, be considered as an investment in the U. S.
Treasury securities.
. Private Activity Bonds Under current tax law all municipal debt is divided
broadly into two groups: governmental purpose bonds and private activity
bonds. Governmental purpose bonds are issued to finance traditional public
purpose projects such as public buildings and roads. Private activity bonds
may be issued by a state or local government or public authority but
principally benefit private users and are considered taxable unless a
specific exemption is provided.
The tax code currently provides exemptions for certain private activity bonds
such as not-for-profit hospital bonds, small-issue industrial development
revenue bonds and mortgage subsidy bonds, which may still be issued as
tax-exempt bonds. Some, but not all, private activity bonds are subject to
alternative minimum tax.
. Industrial Development Bonds Industrial development bonds are considered
Municipal Bonds if the interest paid is exempt from federal income tax. They
are issued by or on behalf of public authorities to raise money to finance
various privately operated facilities for business and manufacturing,
housing, sports, and pollution control. These bonds are also used to finance
public facilities such as airports, mass transit systems, ports, and parking.
The payment of the principal and interest on such bonds is dependent solely
on the ability of the facility's user to meet its financial obligations and
the pledge, if any, of real and personal property so financed as security for
such payment.
Adjustable Rate Securities
Municipal securities may be issued with adjustable interest rates that are
reset periodically by pre-determined formulas or indexes in order to minimize
movements in the principal value of the investment. Such securities may have
long-term maturities, but may be treated as a short-term investment under
certain conditions. Generally, as interest rates decrease or increase, the
potential for capital appreciation or depreciation on these securities is
less than for fixed-rate obligations. These securities may take the following
forms:
Variable Rate Securities Variable rate instruments are those whose terms
provide for the adjustment of their interest rates on set dates and
which, upon such adjustment, can reasonably be expected to have a market
value that approximates its par value. Subject to the provisions of Rule
2a-7 under the Investment Company Act of 1940, (1) a variable rate
instrument, the principal amount of which is scheduled to be paid in 397
days or less, is deemed to have a maturity equal to the period remaining
until the next readjustment of the interest; (2) a variable rate
instrument which is subject to a demand feature which entitles the
purchaser to receive the principal amount of the underlying security or
securities either (i) upon notice of usually 30 days, or (ii) at
specified intervals not exceeding 397 days and upon no more than 30 days
notice is deemed to have a maturity equal to the longer of the period
remaining until the next readjustment of the interest rate or the period
remaining until the principal amount can be recovered through demand; and
(3) an instrument that is issued or guaranteed by the U.S. government or
any agency thereof which has a variable rate of interest readjusted no
less frequently than every 762 days may be deemed to have a maturity
equal to the period remaining until the next readjustment of the interest
rate. Should the provisions of Rule 2a-7 change, the funds will determine
the maturity of these securities in accordance with the amended
provisions of such rule.
Floating Rate Securities Floating rate instruments are those whose terms
provide for the adjustment of their interest rates whenever a specified
interest rate changes and which, at any time, can reasonably be expected
to have a market value that approximates its par value. Subject to the
provisions of Rule 2a-7 under the Investment Company Act of 1940, (1) the
maturity of a floating rate instrument is deemed to be the period
remaining until the date (noted on the face of the instrument) on which
the principal amount must be paid, or in the case of an instrument called
for redemption, the date on which the redemption payment must be made;
and (2) floating rate instruments with demand features are deemed to have
a maturity equal to the period remaining until the principal amount can
be recovered through demand. Should the provisions of Rule 2a-7 change,
the funds will determine the maturity of these securities in accordance
with the amended provisions or such rule.
<PAGE>
Put Option Bonds Long-term obligations with maturities longer than one
year may provide purchasers an optional or mandatory tender of the
security at par value at predetermined intervals, often ranging from one
month to several years (e.g., a 30-year bond with a five-year tender
period). These instruments are deemed to have a maturity equal to the
period remaining to the put date.
Participation Interests The Funds may purchase from third parties
participation interests in all or part of specific holdings of municipal
securities. The purchase may take different forms: in the case of
short-term securities, the participation may be backed by a liquidity
facility that allows the interest to be sold back to the third party
(such as a trust, broker or bank) for a predetermined price of par at
stated intervals. The seller may receive a fee from the Funds in
connection with the arrangement.
In the case of longer-term bonds, the Funds may purchase interests in a
pool of municipal bonds or a single municipal bond or lease without the
right to sell the interest back to the third party.
The Funds will not purchase participation interests unless a satisfactory
opinion of counsel or ruling of the Internal Revenue Service has been
issued that the interest earned from the municipal securities on which
the Funds holds participation interests is exempt from federal income tax
to the Funds. However, there is no guarantee the IRS would treat such
interest income as tax-exempt.
Bond and Balanced Funds
. Residual Interest Bonds are a type of high-risk derivative. The Funds may
purchase municipal bond issues that are structured as two-part, residual
interest bond and variable rate security offerings. The issuer is obligated
only to pay a fixed amount of tax-free income that is to be divided among the
holders of the two securities. The interest rate for the holders of the
variable rate securities will be determined by an index or auction process
held approximately every seven to 35 days while the bondholders will receive
all interest paid by the issuer minus the amount given to the variable rate
security holders and a nominal auction fee. Therefore, the coupon of the
residual interest bonds, and thus the income received, will move inversely
with respect to short-term, seven- to 35-day tax-exempt interest rates. There
is no assurance that the auction will be successful and that the variable
rate security will provide short-term liquidity. The issuer is not obligated
to provide such liquidity. In general, these securities offer a significant
yield advantage over standard municipal securities, due to the uncertainty of
the shape of the yield curve (i.e., short-term versus long-term rates) and
consequent income flows.
Unlike many adjustable rate securities, residual interest bonds are not
necessarily expected to trade at par and in fact present significant market
risks. In certain market environments, residual interest bonds may carry
substantial premiums or be at deep discounts. This is a relatively new
product in the municipal market with limited liquidity to date.
. Embedded Interest Rate Swaps and Caps In a fixed rate, long-term municipal
bond with an interest rate swap attached to it, the bondholder usually
receives the bond's fixed coupon payment as well as a variable rate payment
that represents the difference between a fixed rate for the term of the swap
(which is typically shorter than the bond it is attached to) and a variable
rate, short-term municipal index. The bondholder receives excess income when
short-term rates remain below the fixed interest rate swap rate. If
short-term rates rise above the fixed income swap rate, the bondholder's
income is reduced. At the end of the interest rate swap term, the bond
reverts to a single fixed coupon payment. Embedded interest rate swaps
enhance yields, but also increase interest rate risk.
An embedded interest rate cap allows the bondholder to receive payments
whenever short-term rates rise above a level established at the time of
purchase. They normally are used to hedge against rising short-term interest
rates. Both instruments may be volatile and of limited liquidity, and their
use may adversely affect the Fund's total return. Each Fund will not invest
more than 5% of its total assets in these instruments.
The Funds may invest in other types of derivative instruments as they become
available.
For the purpose of the Funds' investment restrictions, the identification of
the "issuer" of municipal securities which are not general obligation bonds
is made by the Funds' investment manager, T. Rowe Price, on the
<PAGE>
basis of the characteristics of the obligation as described above, the most
significant of which is the source of Funds for the payment of principal and
interest on such securities.
There are, of course, other types of securities that are, or may become
available, which are similar to the foregoing and the Funds may invest in
these securities.
All Funds
When-Issued Securities
New issues of municipal securities are often offered on a when-issued basis;
that is, delivery and payment for the securities normally takes place 15 to
45 days or more after the date of the commitment to purchase. The payment
obligation and the interest rate that will be received on the securities are
each fixed at the time the buyer enters into the commitment. A Fund will only
make a commitment to purchase such securities with the intention of actually
acquiring the securities. However, a Fund may sell these securities before
the settlement date if it is deemed advisable as a matter of investment
strategy. Each Fund will maintain cash, high-grade marketable debt securities
or other suitable cover with its custodian bank equal in value to commitments
for when-issued securities. Such securities either will mature or, if
necessary, be sold on or before the settlement date. Securities purchased on
a when-issued basis and the securities held in a Fund's portfolio are subject
to changes in market value based upon the public perception of the
creditworthiness of the issuer and changes in the level of interest rates
(which will generally result in similar changes in value, i.e., both
experiencing appreciation when interest rates decline and depreciation when
interest rates rise). Therefore, to the extent a Fund remains fully invested
or almost fully invested at the same time that it has purchased securities on
a when-issued basis, there will be greater fluctuations in its net asset
value than if it solely set aside cash to pay for when-issued securities. In
the case of the Money Fund, this could increase the possibility that the
market value of the Fund's assets could vary from $1.00 per share. In
addition, there will be a greater potential for the realization of capital
gains, which are not exempt from federal income tax. When the time comes to
pay for when-issued securities, a Fund will meet its obligations from
then-available cash flow, sale of securities or, although it would not
normally expect to do so, from sale of the when-issued securities themselves
(which may have a value greater or less than the payment obligation). The
policies described in this paragraph are not fundamental and may be changed
by a Fund upon notice to its shareholders.
Bond and Balanced Funds
Forwards
The Funds may purchase bonds on a when-issued basis with longer than standard
settlement dates, in some cases exceeding one to two years. In such cases,
the Funds must execute a receipt evidencing the obligation to purchase the
bond on the specified issue date, and must segregate cash internally to meet
that forward commitment. Municipal "forwards" typically carry a substantial
yield premium to compensate the buyer for the risks associated with a long
when-issued period, including: shifts in market interest rates that could
materially impact the principal value of the bond, deterioration in the
credit quality of the issuer, loss of alternative investment options during
the when-issued period, changes in tax law or issuer actions that would
affect the exempt interest status of the bonds and prevent delivery, failure
of the issuer to complete various steps required to issue the bonds, and
limited liquidity for the buyer to sell the escrow receipts during the
when-issued period.
Investment in Taxable Money Market Securities
Although the Funds expect to be solely invested in municipal securities, for
temporary defensive purposes they may elect to invest in the taxable money
market securities listed below (without limitation) when such action is
deemed to be in the best interests of shareholders. The interest earned on
these money market securities is not exempt from federal income tax and may
be taxable to shareholders as ordinary income.
. U.S. Government Obligations Bills, notes, bonds, and other debt securities
issued by the U.S. Treasury. These are direct obligations of the U.S.
government and differ mainly in the length of their maturities.
<PAGE>
. U.S. Government Agency Securities Issued or guaranteed by U.S.
government-sponsored enterprises and federal agencies. These include
securities issued by the Federal National Mortgage Association, Government
National Mortgage Association, Federal Home Loan Bank, Federal Land Banks,
Farmers Home Administration, Banks for Cooperatives, Federal Intermediate
Credit Banks, Federal Financing Bank, Farm Credit Banks, the Small Business
Association, and the Tennessee Valley Authority. Some of these securities are
supported by the full faith and credit of the U.S. Treasury; the remainder
are supported only by the credit of the instrumentality, which may or may not
include the right of the issuer to borrow from the Treasury.
. Bank Obligations Certificates of deposit, bankers' acceptances, and other
short-term debt obligations. Certificates of deposit are short-term
obligations of commercial banks. A bankers' acceptance is a time draft drawn
on a commercial bank by a borrower, usually in connection with international
commercial transactions. Certificates of deposit may have fixed or variable
rates. The Fund may invest in U.S. banks, foreign branches of U.S. banks,
U.S. branches of foreign banks, and foreign branches of foreign banks.
. Short-Term Corporate Debt Securities Short-term corporate debt securities
rated at least AA by S&P, Moody's or Fitch.
. Commercial Paper Paper rate A-2 or better by S&P, Prime-2 or better by
Moody's, or F-2 or better by Fitch, or, if not rated, is issued by a
corporation having an outstanding debt issue rated A or better by Moody's,
S&P or Fitch and, with respect to the Money Fund, is of equivalent investment
quality as determined by the Board of Directors/Trustees.
. Determination of Maturity of Money Market Securities The Money Fund may only
purchase securities which at the time of investment have remaining maturities
of 397 calendar days or less. The other Funds may also purchase money market
securities. In determining the maturity of money market securities, Funds
will follow the provisions of Rule 2a-7 under the Investment Company Act of
1940.
Tax-Efficient Balanced Fund
Hybrid Instruments
Hybrid Instruments (a type of potentially high-risk derivative) have been
developed and combine the elements of futures contracts or options with those
of debt, preferred equity, or a depository instrument (hereinafter "Hybrid
Instruments"). Generally, a Hybrid Instrument will be a debt security,
preferred stock, depository share, trust certificate, certificate of deposit,
or other evidence of indebtedness on which a portion of or all interest
payments, and/or the principal or stated amount payable at maturity,
redemption, or retirement, is determined by reference to prices, changes in
prices, or differences between prices, of securities, currencies,
intangibles, goods, articles, or commodities (collectively "Underlying
Assets") or by another objective index, economic factor, or other measure,
such as interest rates, currency exchange rates, commodity indices, and
securities indices (collectively "Benchmarks"). Thus, Hybrid Instruments may
take a variety of forms, including, but not limited to, debt instruments with
interest or principal payments or redemption terms determined by reference to
the value of a currency or commodity or securities index at a future point in
time, preferred stock with dividend rates determined by reference to the
value of a currency, or convertible securities with the conversion terms
related to a particular commodity.
Hybrid Instruments can be an efficient means of creating exposure to a
particular market, or segment of a market, with the objective of enhancing
total return. For example, a Fund may wish to take advantage of expected
declines in interest rates in several European countries, but avoid the
transaction costs associated with buying and currency-hedging the foreign
bond positions. One solution would be to purchase a U.S. dollar-denominated
Hybrid Instrument whose redemption price is linked to the average three-year
interest rate in a designated group of countries. The redemption price
formula would provide for payoffs of greater than par if the average interest
rate was lower than a specified level, and payoffs of less than par if rates
were above the specified level. Furthermore, the Fund could limit the
downside risk of the security by establishing a minimum redemption price so
that the principal paid at maturity could not be below a predetermined
minimum level if interest rates were to rise significantly. The purpose of
this arrangement, known as a structured security with an embedded put option,
would be to give the Fund the desired European bond
<PAGE>
exposure while avoiding currency risk, limiting downside market risk, and
lowering transactions costs. Of course, there is no guarantee that the
strategy will be successful, and the Fund could lose money if, for example,
interest rates do not move as anticipated or credit problems develop with the
issuer of the Hybrid.
The risks of investing in Hybrid Instruments reflect a combination of the
risks of investing in securities, options, futures and currencies. Thus, an
investment in a Hybrid Instrument may entail significant risks that are not
associated with a similar investment in a traditional debt instrument that
has a fixed principal amount, is denominated in U.S. dollars, or bears
interest either at a fixed rate or a floating rate determined by reference to
a common, nationally published benchmark. The risks of a particular Hybrid
Instrument will, of course, depend upon the terms of the instrument, but may
include, without limitation, the possibility of significant changes in the
Benchmarks or the prices of Underlying Assets to which the instrument is
linked. Such risks generally depend upon factors which are unrelated to the
operations or credit quality of the issuer of the Hybrid Instrument and which
may not be readily foreseen by the purchaser, such as economic and political
events, the supply and demand for the Underlying Assets, and interest rate
movements. In recent years, various Benchmarks and prices for Underlying
Assets have been highly volatile, and such volatility may be expected in the
future. Reference is also made to the discussion of futures, options, and
forward contracts herein for a discussion of the risks associated with such
investments.
Hybrid Instruments are potentially more volatile and carry greater market
risks than traditional debt instruments. Depending on the structure of the
particular Hybrid Instrument, changes in a Benchmark may be magnified by the
terms of the Hybrid Instrument and have an even more dramatic and substantial
effect upon the value of the Hybrid Instrument. Also, the prices of the
Hybrid Instrument and the Benchmark or Underlying Asset may not move in the
same direction or at the same time.
Hybrid Instruments may bear interest or pay preferred dividends at below
market (or even relatively nominal) rates. Alternatively, Hybrid Instruments
may bear interest at above market rates but bear an increased risk of
principal loss (or gain). The latter scenario may result if "leverage" is
used to structure the Hybrid Instrument. Leverage risk occurs when the Hybrid
Instrument is structured so that a given change in a Benchmark or Underlying
Asset is multiplied to produce a greater value change in the Hybrid
Instrument, thereby magnifying the risk of loss as well as the potential for
gain.
Hybrid Instruments may also carry liquidity risk since the instruments are
often "customized" to meet the portfolio needs of a particular investor, and
therefore, the number of investors that are willing and able to buy such
instruments in the secondary market may be smaller than that for more
traditional debt securities. In addition, because the purchase and sale of
Hybrid Instruments could take place in an over-the-counter market without the
guarantee of a central clearing organization or in a transaction between the
Fund and the issuer of the Hybrid Instrument, the creditworthiness of the
counter party of issuer of the Hybrid Instrument would be an additional risk
factor which the Fund would have to consider and monitor. Hybrid Instruments
also may not be subject to regulation of the Commodities Futures Trading
Commission ("CFTC"), which generally regulates the trading of commodity
futures by U.S. persons, the SEC, which regulates the offer and sale of
securities by and to U.S. persons, or any other governmental regulatory
authority.
The various risks discussed above, particularly the market risk of such
instruments, may in turn cause significant fluctuations in the net asset
value of the Fund. Accordingly, the Fund will limit its investments in Hybrid
Instruments to 10% of total assets. However, because of their volatility, it
is possible that the Fund's investment in Hybrid Instruments will account for
more than 10% of the Fund's return (positive or negative).
Illiquid or Restricted Securities
Restricted securities may be sold only in privately negotiated transactions
or in a public offering with respect to which a registration statement is in
effect under the Securities Act of 1933 (the "1933 Act"). Where registration
is required, the Fund may be obligated to pay all or part of the registration
expenses, and a considerable period may elapse between the time of the
decision to sell and the time the Fund may be permitted to sell a security
under an effective registration statement. If, during such a period, adverse
market conditions were to develop, the Fund might obtain a less favorable
price than prevailed when it decided to sell. Restricted securities will be
priced at fair value as determined in accordance with procedures prescribed
<PAGE>
by the Fund's Board of Directors/Trustees. If, through the appreciation of
illiquid securities or the depreciation of liquid securities, the Fund should
be in a position where more than 15% of the value of its net assets is
invested in illiquid assets, including restricted securities, the Fund will
take appropriate steps to protect liquidity.
Notwithstanding the above, the Fund may purchase securities which, while
privately placed, are eligible for purchase and sale under Rule 144A under
the 1933 Act. This rule permits certain qualified institutional buyers, such
as the Fund, to trade in privately placed securities even though such
securities are not registered under the 1933 Act. T. Rowe Price, under the
supervision of the Fund's Board of Directors/Trustees, will consider whether
securities purchased under Rule 144A are illiquid and thus subject to the
Fund's restriction of investing no more than 15% of its net assets in
illiquid securities. A determination of whether a Rule 144A security is
liquid or not is a question of fact. In making this determination, T. Rowe
Price will consider the trading markets for the specific security taking into
account the unregistered nature of a Rule 144A security. In addition, T. Rowe
Price could consider the (1) frequency of trades and quotes, (2) number of
dealers and potential purchases, (3) dealer undertakings to make a market,
and (4) the nature of the security and of marketplace trades (e.g., the time
needed to dispose of the security, the method of soliciting offers, and the
mechanics of transfer). The liquidity of Rule 144A securities would be
monitored and, if as a result of changed conditions it is determined that a
Rule 144A security is no longer liquid, the Fund's holdings of illiquid
securities would be reviewed to determine what, if any, steps are required to
assure that the Fund does not invest more than 15% of its net assets in
illiquid securities. Investing in Rule 144A securities could have the effect
of increasing the amount of the Fund's assets invested in illiquid securities
if qualified institutional buyers are unwilling to purchase such securities.
Warrants
The Fund may acquire warrants. Warrants are pure speculation in that they
have no voting rights, pay no dividends, and have no rights with respect to
the assets of the corporation issuing them. Warrants basically are options to
purchase equity securities at a specific price valid for a specific period of
time. They do not represent ownership of the securities, but only the right
to buy them. Warrants differ from call options in that warrants are issued by
the issuer of the security which may be purchased on their exercise, whereas
call options may be written or issued by anyone. The prices of warrants do
not necessarily move parallel to the prices of the underlying securities.
PORTFOLIO MANAGEMENT PRACTICES
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Bond Funds
Futures Contracts
Futures contracts are a type of potentially high-risk derivative.
Transactions in Futures
The Fund may enter into futures contracts including stock index, interest
rate, and currency futures ("futures" or "futures contracts").
Tax-Efficient Balanced Fund
The Tax-Efficient Balanced Fund may enter into futures contracts including
stock index, interest rate, and currency futures ("futures or futures
contracts"). The nature of such futures and the regulatory limitations and
risks to which they are subject are the same as those described below.
Stock index futures contracts may be used to provide a hedge for a portion of
the Fund's portfolio, as a cash management tool, or as an efficient way for
T. Rowe Price to implement either an increase or decrease in portfolio market
exposure in response to changing market conditions. The Fund may purchase or
sell futures contracts with respect to any stock index. Nevertheless, to
hedge the Fund's portfolio successfully, the Fund
<PAGE>
must sell futures contacts with respect to indices or subindices whose
movements will have a significant correlation with movements in the prices of
the Fund's portfolio securities.
Interest rate or currency futures contracts may be used as a hedge against
changes in prevailing levels of interest rates or currency exchange rates in
order to establish more definitely the effective return on securities or
currencies held or intended to be acquired by the Fund. In this regard, the
Fund could sell interest rate or currency futures as an offset against the
effect of expected increases in interest rates or currency exchange rates and
purchase such futures as an offset against the effect of expected declines in
interest rates or currency exchange rates.
All Funds
The Fund will enter into futures contracts which are traded on national (and
for the Tax-Efficient Balanced Fund, foreign) futures exchanges, and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading in the United States are regulated under the Commodity
Exchange Act by the CFTC. Futures for the Tax-Efficient Balanced Fund may
also be traded in London, at the London International Financial Futures
Exchange, in Paris, at the MATIF, and in Tokyo, at the Tokyo Stock Exchange.
Although techniques other than the sale and purchase of futures contracts
could be used for the above-referenced purposes, futures contracts offer an
effective and relatively low cost means of implementing the Fund's objectives
in these areas.
Regulatory Limitations
The Fund will engage in futures contracts and options thereon only for bona
fide hedging, yield enhancement, and risk management purposes, in each case
in accordance with rules and regulations of the CFTC.
The Fund may not purchase or sell futures contracts or related options if,
with respect to positions which do not qualify as bona fide hedging under
applicable CFTC rules, the sum of the amounts of initial margin deposits and
premium paid on those positions would exceed 5% of the net asset value of the
Fund after taking into account unrealized profits and unrealized losses on
any such contracts it has entered into; provided, however, that in the case
of an option that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5% limitation. For purposes of this
policy, options on futures contracts and foreign currency options traded on a
commodities exchange will be considered "related options." This policy may be
modified by the Board of Directors/Trustees without a shareholder vote and
does not limit the percentage of the Fund's assets at risk to 5%.
In instances involving the purchase of futures contracts or the writing of
call or put options thereon by the Fund, an amount of cash, U.S. government
securities, other liquid, high-grade debt obligations, or other suitable
cover as permitted by the SEC, equal to the market value of the futures
contracts and options thereon (less any related margin deposits), will be
identified by the Fund to cover the position, or alternative cover (such as
owning an offsetting position) will be employed. Assets used as cover or held
in an identified account cannot be sold while the position in the
corresponding option or future is open, unless they are replaced with similar
assets. As a result, the commitment of a large portion of a Fund's assets to
cover or identified accounts could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
If the CFTC or other regulatory authorities adopt different (including less
stringent) or additional restrictions, the Fund would comply with such new
restrictions.
Trading in Futures Contracts
A futures contract provides for the future sale by one party and purchase by
another party of a specified amount of a specific financial instrument (e.g.,
units of a stock index) for a specified price, date, time and place
designated at the time the contract is made. Brokerage fees are incurred when
a futures contract is bought or sold and margin deposits must be maintained.
Entering into a contract to buy is commonly referred to as buying or
purchasing a contract or holding a long position. Entering into a contract to
sell is commonly referred to as selling a contract or holding a short
position.
<PAGE>
Unlike when the Fund purchases or sells a security, no price would be paid or
received by the Fund upon the purchase or sale of a futures contract. Upon
entering into a futures contract, and to maintain the Fund's open positions
in futures contracts, the Fund would be required to deposit with its
custodian in a segregated account in the name of the futures broker an amount
of cash, U.S. government securities, suitable money market instruments,
liquid, high-grade debt securities, or other suitable cover as determined by
the SEC, known as "initial margin." The margin required for a particular
futures contract is set by the exchange on which the contract is traded, and
may be significantly modified from time to time by the exchange during the
term of the contract. Futures contracts are customarily purchased and sold on
margins that may range upward from less than 5% of the value of the contract
being traded.
If the price of an open futures contract changes (by increase in the case of
a sale or by decrease in the case of a purchase) so that the loss on the
futures contract reaches a point at which the margin on deposit does not
satisfy margin requirements, the broker will require an increase in the
margin. However, if the value of a position increases because of favorable
price changes in the futures contract so that the margin deposit exceeds the
required margin, the broker will pay the excess to the Fund.
These subsequent payments, called "variation margin," to and from the futures
broker, are made on a daily basis as the price of the underlying assets
fluctuate, making the long and short positions in the futures contract more
or less valuable, a process known as "marking to market." The Fund expects to
earn interest income on its margin deposits.
Although certain futures contracts, by their terms, require actual future
delivery of and payment for the underlying instruments, in practice most
futures contracts are usually closed out before the delivery date. Closing
out an open futures contract purchase or sale is effected by entering into an
offsetting futures contract sale or purchase, respectively, for the same
aggregate amount of the identical securities and the same delivery date. If
the offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
As an example of an offsetting transaction in which the underlying instrument
is not delivered, the contractual obligations arising from the sale of one
contract of September Treasury bills on an exchange may be fulfilled at any
time before delivery of the contract is required (i.e., on a specified date
in September, the "delivery month") by the purchase of one contract of
September Treasury bills on the same exchange. In such instance, the
difference between the price at which the futures contract was sold and the
price paid for the offsetting purchase, after allowance for transaction
costs, represents the profit or loss to the Fund.
Tax-Efficient Balanced Fund
For example, the S&P's 500 Stock Index is made up of 500 selected common
stocks, most of which are listed on the New York Stock Exchange. The S&P 500
Index assigns relative weightings to the common stocks included in the Index,
and the Index fluctuates with changes in the market values of those common
stocks. In the case of futures contracts on the S&P 500 Index, the contracts
are to buy or sell 250 units. Thus, if the value of the S&P 500 Index were
$150, one contract would be worth $37,500 (250 units x $150). The stock index
futures contract specifies that no delivery of the actual stocks making up
the index will take place. Instead, settlement in cash occurs. Over the life
of the contract, the gain or loss realized by the Fund will equal the
difference between the purchase (or sale) price of the contract and the price
at which the contract is terminated. For example, if the Fund enters into a
futures contract to buy 250 units of the S&P 500 Index at a specified future
date at a contract price of $150 and the S&P 500 Index is at $154 on that
future date, the Fund will gain $1,000 (250 units x gain of $4). If the Fund
enters into a futures contract to sell 250 units of the stock index at a
specified future date at a contract price of $150 and the S&P 500 Index is at
$152 on that future date, the Fund will lose $500 (250 units x loss of $2).
<PAGE>
Special Risks of Transactions in Futures Contracts
. Volatility and Leverage The prices of futures contracts are volatile and are
influenced, among other things, by actual and anticipated changes in the
market and interest rates, which in turn are affected by fiscal and monetary
policies and national and international political and economic events.
Most United States futures exchanges limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount that the price of a futures contract may
vary either up or down from the previous day's settlement price at the end of
a trading session. Once the daily limit has been reached in a particular type
of futures contract, no trades may be made on that day at a price beyond that
limit. The daily limit governs only price movement during a particular
trading day and therefore does not limit potential losses, because the limit
may prevent the liquidation of unfavorable positions. Futures contract prices
have occasionally moved to the daily limit for several consecutive trading
days with little or no trading, thereby preventing prompt liquidation of
futures positions and subjecting some futures traders to substantial losses.
Margin deposits required on futures trading are low. As a result, a
relatively small price movement in a futures contract may result in immediate
and substantial loss, as well as gain, to the investor. For example, if at
the time of purchase, 10% of the value of the futures contract is deposited
as margin, a subsequent 10% decrease in the value of the futures contract
would result in a total loss of the margin deposit, before any deduction for
the transaction costs, if the account were then closed out. A 15% decrease
would result in a loss equal to 150% of the original margin deposit, if the
contract were closed out. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, the Fund would presumably have sustained comparable losses if,
instead of the futures contract, it had invested in the underlying financial
instrument and sold it after decline. Furthermore, in the case of a futures
contract purchase, in order to be certain that the Fund has sufficient assets
to satisfy its obligations under a futures contract, the Fund earmarks to the
futures contract money market instruments equal in value to the current value
of the underlying instrument less the margin deposit.
. Liquidity The Fund may elect to close some or all of its futures positions
at any time prior to their expiration. The Fund would do so to reduce
exposure represented by long futures positions or short futures positions.
The Fund may close its positions by taking opposite positions which would
operate to terminate the Fund's position in the futures contracts. Final
determinations of variation margin would then be made, additional cash would
be required to be paid by or released to the Fund, and the Fund would realize
a loss or a gain.
Futures contracts may be closed out only on the exchange or board of trade
where the contracts were initially traded. Although the Fund intends to
purchase or sell futures contracts only on exchanges or boards of trade where
there appears to be an active market, there is no assurance that a liquid
market on an exchange or board of trade will exist for any particular
contract at any particular time. In such event, it might not be possible to
close a futures contract, and in the event of adverse price movements, the
Fund would continue to be required to make daily cash payments of variation
margin. However, in the event futures contracts have been used to hedge the
underlying instruments, the Fund would continue to hold the underlying
instruments subject to the hedge until the futures contracts could be
terminated. In such circumstances, an increase in the price of underlying
instruments, if any, might partially or completely offset losses on the
futures contract. However, as described next, there is no guarantee that the
price of the underlying instruments will, in fact, correlate with the price
movements in the futures contract and thus provide an offset to losses on a
futures contract.
. Hedging Risk A decision of whether, when, and how to hedge involves skill
and judgment, and even a well-conceived hedge may be unsuccessful to some
degree because of unexpected market behavior, market or interest rate trends.
There are several risks in connection with the use by the Fund of futures
contracts as a hedging device. One risk arises because of the imperfect
correlation between movements in the prices of the futures contracts and
movements in the prices of the underlying instruments which are the subject
of the hedge. T. Rowe Price will, however, attempt to reduce this risk by
entering into futures contracts whose movements, in its judgment, will have a
significant correlation with movements in the prices of the Fund's underlying
instruments sought to be hedged.
<PAGE>
Successful use of futures contracts by the Fund for hedging purposes is also
subject to T. Rowe Price's ability to correctly predict movements in the
direction of the market. It is possible that, when the Fund has sold futures
to hedge its portfolio against a decline in the market, the index, indices,
or instruments underlying futures might advance and the value of the
underlying instruments held in the Fund's portfolio might decline. If this
were to occur, the Fund would lose money on the futures and also would
experience a decline in value in its underlying instruments. However, while
this might occur to a certain degree, T. Rowe Price believes that over time
the value of the Fund's portfolio will tend to move in the same direction as
the market indices used to hedge the portfolio. It is also possible that, if
the Fund were to hedge against the possibility of a decline in the market
(adversely affecting the underlying instruments held in its portfolio) and
prices instead increased, the Fund would lose part or all of the benefit of
increased value of those underlying instruments that it has hedged, because
it would have offsetting losses in its futures positions. In addition, in
such situations, if the Fund had insufficient cash, it might have to sell
underlying instruments to meet daily variation margin requirements. Such
sales of underlying instruments might be, but would not necessarily be, at
increased prices (which would reflect the rising market). The Fund might have
to sell underlying instruments at a time when it would be disadvantageous to
do so.
In addition to the possibility that there might be an imperfect correlation,
or no correlation at all, between price movements in the futures contracts
and the portion of the portfolio being hedged, the price movements of futures
contracts might not correlate perfectly with price movements in the
underlying instruments due to certain market distortions. First, all
participants in the futures market are subject to margin deposit and
maintenance requirements. Rather than meeting additional margin deposit
requirements, investors might close futures contracts through offsetting
transactions, which could distort the normal relationship between the
underlying instruments and futures markets. Second, the margin requirements
in the futures market are less onerous than margin requirements in the
securities markets and, as a result, the futures market might attract more
speculators than the securities markets do. Increased participation by
speculators in the futures market might also cause temporary price
distortions. Due to the possibility of price distortion in the futures market
and also because of imperfect correlation between price movements in the
underlying instruments and movements in the prices of futures contracts, even
a correct forecast of general market trends by T. Rowe Price might not result
in a successful hedging transaction over a very short time period.
Options on Futures Contracts
The Fund might trade in municipal bond index option futures or similar
options on futures developed in the future. In addition, the Fund may also
trade in options on futures contracts on U.S. government securities and any
U.S. government securities futures index contract which might be developed.
In the opinion of T. Rowe Price, there is a high degree of correlation in the
interest rate, and price movements of U.S. government securities and
municipal securities. However, the U.S. government securities market and
municipal securities markets are independent and may not move in tandem at
any point in time.
The Fund may purchase put options on futures contracts to hedge its portfolio
of municipal securities against the risk of rising interest rates, and the
consequent decline in the prices of the municipal securities it owns. The
Funds will also write call options on futures contracts as a hedge against a
modest decline in prices of the municipal securities held in the Fund's
portfolio. If the futures price at expiration of a written call option is
below the exercise price, the Fund will retain the full amount of the option
premium, thereby partially hedging against any decline that may have occurred
in the Fund's holdings of debt securities. If the futures price when the
option is exercised is above the exercise price, however, the Fund will incur
a loss, which may be wholly or partially offset by the increase of the value
of the securities in the Fund's portfolio which were being hedged.
Writing a put option on a futures contract serves as a partial hedge against
an increase in the value of securities the Fund intends to acquire. If the
futures price at expiration of the option is above the exercise price, the
Fund will retain the full amount of the option premium which provides a
partial hedge against any increase that may have occurred in the price of the
debt securities the Fund intends to acquire. If the futures price when the
option is exercised is below the exercise price, however, the Fund will incur
a loss, which may be wholly or partially offset by the decrease in the price
of the securities the Fund intends to acquire.
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Options (another type of potentially high-risk derivative) on futures are
similar to options on underlying instruments except that options on futures
give the purchaser the right, in return for the premium paid, to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put), rather than to purchase or sell the
futures contract, at a specified exercise price at any time during the period
of the option. Upon exercise of the option, the delivery of the futures
position by the writer of the option to the holder of the option will be
accompanied by the delivery of the accumulated balance in the writer's
futures margin account which represents the amount by which the market price
of the futures contract, at exercise, exceeds (in the case of a call) or is
less than (in the case of a put) the exercise price of the option on the
futures contract. Purchasers of options who fail to exercise their options
prior to the exercise date suffer a loss of the premium paid.
From time to time a single order to purchase or sell futures contracts (or
options thereon) may be made on behalf of the Fund and other T. Rowe Price
Funds. Such aggregated orders would be allocated among the Fund and the other
T. Rowe Price Funds in a fair and non-discriminatory manner.
Tax-Efficient Balanced Fund
As an alternative to writing or purchasing call and put options on stock
index futures, the Fund may write or purchase call and put options on stock
indices. Such options would be used in a manner similar to the use of options
on futures contracts.
Special Risks of Transactions in Options on Futures Contracts
The risks described under "Special Risks in Transactions on Futures
Contracts" are substantially the same as the risks of using options on
futures. In addition, where the Fund seeks to close out an option position by
writing or buying an offsetting option covering the same index, underlying
instrument or contract and having the same exercise price and expiration
date, its ability to establish and close out positions on such options will
be subject to the maintenance of a liquid secondary market. Reasons for the
absence of a liquid secondary market on an exchange include the following:
(i) there may be insufficient trading interest in certain options; (ii)
restrictions may be imposed by an exchange on opening transactions or closing
transactions or both; (iii) trading halts, suspensions or other restrictions
may be imposed with respect to particular classes or series of options, or
underlying instruments; (iv) unusual or unforeseen circumstances may
interrupt normal operations on an exchange; (v) the facilities of an exchange
or a clearing corporation may not at all times be adequate to handle current
trading volume; or (vi) one or more exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which
event the secondary market on that exchange (or in the class or series of
options) would cease to exist, although outstanding options on the exchange
that had been issued by a clearing corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms.
There is no assurance that higher than anticipated trading activity or other
unforeseen events might not, at times, render certain of the facilities of
any of the clearing corporations inadequate, and thereby result in the
institution by an exchange of special procedures which may interfere with the
timely execution of customers' orders.
In addition, the correlation between movements in the price of options on
futures contracts and movements in the price of the securities hedged can
only be approximate. This risk is significantly increased when an option on a
U.S. government securities future or an option on some type of index future
is used as a proxy for hedging a portfolio consisting of other types of
securities. Another risk is that the movements in the price of options on
futures contract and the value of the call increases by more than the
increase in the value of the securities held as cover, the Fund may realize a
loss on the call which is not completely offset by the appreciation in the
price of the securities held as cover and the premium received for writing
the call.
The successful use of options on futures contracts requires special expertise
and techniques different from those involved in portfolio securities
transactions. A decision of whether, when and how to hedge involves skill and
judgment, and even a well-conceived hedge may be unsuccessful to some degree
because of unexpected market behavior or interest rate trends. During periods
when municipal securities market prices
<PAGE>
are appreciating, the Fund may experience poorer overall performance than if
it had not entered into any options on futures contracts.
General Considerations Transactions by the Fund in options on futures will be
subject to limitations established by each of the exchanges, boards of trade
or other trading facilities governing the maximum number of options in each
class which may be written or purchased by a single investor or group of
investors acting in concert, regardless of whether the options are written on
the same or different exchanges, boards of trade or other trading facilities
or are held or written in one or more accounts or through one or more
brokers. Thus, the number of contracts which the Fund may write or purchase
may be affected by contracts written or purchased by other investment
advisory clients of T. Rowe Price. An exchange, board of trade or other
trading facility may order the liquidations of positions found to be in
excess of these limits, and it may impose certain other sanctions.
Additional Futures and Options Contracts
Although the Fund has no current intention of engaging in futures or options
transactions other than those described above, it reserves the right to do
so. Such futures and options trading might involve risks which differ from
those involved in the futures and options described above.
Tax-Efficient Balanced Fund
Foreign Futures and Options
Participation in foreign futures and foreign options transactions involves
the execution and clearing of trades on or subject to the rules of a foreign
board of trade. Neither the National Futures Association nor any domestic
exchange regulates activities of any foreign boards of trade, including the
execution, delivery and clearing of transactions, or has the power to compel
enforcement of the rules of a foreign board of trade or any applicable
foreign law. This is true even if the exchange is formally linked to a
domestic market so that a position taken on the market may be liquidated by a
transaction on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or foreign
options transaction occurs. For these reasons, when the Fund trades foreign
futures or foreign options contracts, it may not be afforded certain of the
protective measures provided by the Commodity Exchange Act, the CFTC's
regulations and the rules of the National Futures Association and any
domestic exchange, including the right to use reparations proceedings before
the CFTC and arbitration proceedings provided by the National Futures
Association or any domestic futures exchange. In particular, funds received
from the Fund for foreign futures or foreign options transactions may not be
provided the same protections as funds received in respect of transactions on
United States futures exchanges. In addition, the price of any foreign
futures or foreign options contract and, therefore, the potential profit and
loss thereon may be affected by any variance in the foreign exchange rate
between the time the Fund's order is placed and the time it is liquidated,
offset or exercised.
Foreign Currency Transactions
A forward foreign currency exchange contract involves an obligation to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts are principally traded
in the interbank market conducted directly between currency traders (usually
large, commercial banks) and their customers. A forward contract generally
has no deposit requirement, and no commissions are charged at any stage for
trades.
The Fund may enter into forward contracts for a variety of purposes in
connection with the management of the foreign securities portion of its
portfolio. The Fund's use of such contracts would include, but not be limited
to, the following:
First, when the Fund enters into a contract for the purchase or sale of a
security denominated in a foreign currency, it may desire to "lock in" the
U.S. dollar price of the security. By entering into a forward contract for
the purchase or sale, for a fixed amount of dollars, of the amount of foreign
currency involved in the underlying security transactions, the Fund will be
able to protect itself against a possible loss resulting from
<PAGE>
an adverse change in the relationship between the U.S. dollar and the subject
foreign currency during the period between the date the security is purchased
or sold and the date on which payment is made or received.
Second, when T. Rowe Price believes that one currency may experience a
substantial movement against another currency, including the U.S. dollar, it
may enter into a forward contract to sell or buy the amount of the former
foreign currency, approximating the value of some or all of the Fund's
portfolio securities denominated in such foreign currency. Alternatively,
where appropriate, the Fund may hedge all or part of its foreign currency
exposure through the use of a basket of currencies or a proxy currency where
such currency or currencies act as an effective proxy for other currencies.
In such a case, the Fund may enter into a forward contract where the amount
of the foreign currency to be sold exceeds the value of the securities
denominated in such currency. The use of this basket hedging technique may be
more efficient and economical than entering into separate forward contracts
for each currency held in the Fund. The precise matching of the forward
contract amounts and the value of the securities involved will not generally
be possible since the future value of such securities in foreign currencies
will change as a consequence of market movements in the value of those
securities between the date the forward contract is entered into and the date
it matures. The projection of short-term currency market movement is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain. Under normal circumstances, consideration of
the prospect for currency parties will be incorporated into the longer term
investment decisions made with regard to overall diversification strategies.
However, T. Rowe Price believes that it is important to have the flexibility
to enter into such forward contracts when it determines that the best
interests of the Fund will be served.
The Fund may enter into forward contacts for any other purpose consistent
with the Fund's investment objective and program. However, the Fund will not
enter into a forward contract, or maintain exposure to any such contract(s),
if the amount of foreign currency required to be delivered thereunder would
exceed the Fund's holdings of liquid, high-grade debt securities, currency
available for cover of the forward contract(s) or other suitable cover as
permitted by the SEC. In determining the amount to be delivered under a
contract, the Fund may net offsetting positions.
At the maturity of a forward contract, the Fund may sell the portfolio
security and make delivery of the foreign currency, or it may retain the
security and either extend the maturity of the forward contract (by "rolling"
that contract forward) or may initiate a new forward contract.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss (as described below) to the
extent that there has been movement in forward contract prices. If the Fund
engages in an offsetting transaction, it may subsequently enter into a new
forward contract to sell the foreign currency. Should forward prices decline
during the period between the Fund's entering into a forward contract for the
sale of a foreign currency and the date it enters into an offsetting contract
for the purchase of the foreign currency, the Fund will realize a gain to the
extent the price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward prices increase, the
Fund will suffer a loss to the extent of the price of the currency it has
agreed to purchase exceeds the price of the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange contracts will
generally be limited to the transactions described above. However, the Fund
reserves the right to enter into forward foreign currency contracts for
different purposes and under different circumstances. Of course, the Fund is
not required to enter into forward contracts with regard to its foreign
currency-denominated securities and will not do so unless deemed appropriate
by T. Rowe Price. It also should be realized that this method of hedging
against a decline in the value of a currency does not eliminate fluctuations
in the underlying prices of the securities. It simply establishes a rate of
exchange at a future date. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the hedged
currency, at the same time, they tend to limit any potential gain which might
result from an increase in the value of that currency.
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend to convert its holdings of foreign currencies into U.S. dollars on
a daily basis. It will do so from time to time, and investors should be aware
of the costs of currency conversion. Although foreign exchange dealers do not
charge a fee for
<PAGE>
conversion, they do realize a profit based on the difference (the "spread")
between the prices at which they are buying and selling various currencies.
Thus, a dealer may offer to sell a foreign currency to the Fund at one rate,
while offering a lesser rate of exchange should the Fund desire to resell
that currency to the dealer.
Federal Tax Treatment of Options, Futures Contracts, and Forward Foreign
Exchange Contracts
Although the Fund invests almost exclusively in securities that generate
income that is exempt from federal income taxes, the Fund may enter into
certain option, futures, and foreign exchange contracts, including options
and futures on currencies, which will be treated as Section 1256 contracts or
straddles that are not exempt from such taxes. Therefore, use of the
investment techniques described above could result in taxable income to
shareholders of the Fund.
Transactions which are considered Section 1256 contracts will be considered
to have been closed at the end of the Fund's fiscal year and any gains or
losses will be recognized for tax purposes at that time. Gains or losses
recognized from the normal closing or settlement of such transactions will be
characterized as 60% long-term capital gain or loss and 40% short-term
capital gain or loss, without regard to the holding period of the contract.
The Fund will be required to distribute net gains on such transactions to
shareholders even though it may not have closed the transaction and received
cash to pay such distributions.
Options, futures and forward foreign exchange contracts, including options
and futures on currencies, which offset a foreign dollar denominated bond or
currency position may be considered straddles for tax purposes, in which case
a loss on any position in a straddle will be subject to deferral to the
extent of unrealized gain in an offsetting position. The holding period of
the securities or currencies comprising the straddle will be deemed not to
begin until the straddle is terminated. The holding period of the security
offsetting an "in-the-money qualified covered call" option on an equity
security will not include the period of time the option is outstanding.
Losses on written covered calls and purchased puts on securities, excluding
certain "qualified covered call" options on equity securities, may be
long-term capital losses, if the security covering the option was held for
more than 12 months prior to the writing of the option.
In order for the Fund to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income, i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or currencies. Tax regulations could be issued limiting the extent
that net gain realized from option, futures or foreign forward exchange
contracts on currencies is qualifying income for purposes of the 90%
requirement.
As a result of the "Taxpayer Relief Act of 1997," entering into certain
options, futures contracts, or forward contracts may result in the
"constructive sale" of offsetting stocks or debt securities of the Fund.
Options on Securities
Options are another type of potentially high-risk derivative.
Bond and Money Funds
The Funds have no current intention of investing in options on securities,
although they reserve the right to do so. Appropriate disclosure would be
added to the Funds' prospectus and Statement of Additional Information when
and if the Funds decide to invest in options.
Tax-Efficient Balanced Fund
Writing Covered Call Options
The Fund may write (sell) American or European style "covered" call options
and purchase options to close out options previously written by the Fund. In
writing covered call options, the Fund expects to generate additional premium
income which should serve to enhance the Fund's total return and reduce the
effect of any price decline of the security or currency involved in the
option. Covered call options will generally be written on securities or
currencies which, in T. Rowe Price's opinion, are not expected to have any
major
<PAGE>
price increases or moves in the near future but which, over the long term,
are deemed to be attractive investments for the Fund.
A call option gives the holder (buyer) the "right to purchase" a security or
currency at a specified price (the exercise price) at expiration of the
option (European style) or at any time until a certain date (the expiration
date) (American style). So long as the obligation of the writer of a call
option continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to deliver the underlying
security or currency against payment of the exercise price. This obligation
terminates upon the expiration of the call option, or such earlier time at
which the writer effects a closing purchase transaction by repurchasing an
option identical to that previously sold. To secure his obligation to deliver
the underlying security or currency in the case of a call option, a writer is
required to deposit in escrow the underlying security or currency or other
assets in accordance with the rules of a clearing corporation.
The Fund will write only covered call options. This means that the Fund will
own the security or currency subject to the option or an option to purchase
the same underlying security or currency, having an exercise price equal to
or less than the exercise price of the "covered" option, or will establish
and maintain with its custodian for the term of the option, an account
consisting of cash, U.S. government securities, other liquid high-grade debt
obligations, or other suitable cover as permitted by the SEC having a value
equal to the fluctuating market value of the optioned securities or
currencies.
Portfolio securities or currencies on which call options may be written will
be purchased solely on the basis of investment considerations consistent with
the Fund's investment objective. The writing of covered call options is a
conservative investment technique believed to involve relatively little risk
(in contrast to the writing of naked or uncovered options, which the Fund
will not do), but capable of enhancing the Fund's total return. When writing
a covered call option, a Fund, in return for the premium, gives up the
opportunity for profit from a price increase in the underlying security or
currency above the exercise price, but conversely retains the risk of loss
should the price of the security or currency decline. Unlike one who owns
securities or currencies not subject to an option, the Fund has no control
over when it may be required to sell the underlying securities or currencies,
since it may be assigned an exercise notice at any time prior to the
expiration of its obligation as a writer. If a call option which the Fund has
written expires, the Fund will realize a gain in the amount of the premium;
however, such gain may be offset by a decline in the market value of the
underlying security or currency during the option period. If the call option
is exercised, the Fund will realize a gain or loss from the sale of the
underlying security or currency. The Fund does not consider a security or
currency covered by a call to be "pledged" as that term is used in the Fund's
policy which limits the pledging or mortgaging of its assets.
The premium received is the market value of an option. The premium the Fund
will receive from writing a call option will reflect, among other things, the
current market price of the underlying security or currency, the relationship
of the exercise price to such market price, the historical price volatility
of the underlying security or currency, and the length of the option period.
Once the decision to write a call option has been made, T. Rowe Price, in
determining whether a particular call option should be written on a
particular security or currency, will consider the reasonableness of the
anticipated premium and the likelihood that a liquid secondary market will
exist for those options. The premium received by the Fund for writing covered
call options will be recorded as a liability of the Fund. This liability will
be adjusted daily to the option's current market value, which will be the
latest sale price at the time at which the net asset value per share of the
Fund is computed (close of the New York Stock Exchange), or, in the absence
of such sale, the latest asked price. The option will be terminated upon
expiration of the option, the purchase of an identical option in a closing
transaction, or delivery of the underlying security or currency upon the
exercise of the option.
Closing transactions will be effected in order to realize a profit on an
outstanding call option, to prevent an underlying security or currency from
being called, or, to permit the sale of the underlying security or currency.
Furthermore, effecting a closing transaction will permit the Fund to write
another call option on the underlying security or currency with either a
different exercise price or expiration date or both. If the Fund desires to
sell a particular security or currency from its portfolio on which it has
written a call option, or purchased a put option, it will seek to effect a
closing transaction prior to, or concurrently with, the sale of
<PAGE>
the security or currency. There is, of course, no assurance that the Fund
will be able to effect such closing transactions at favorable prices. If the
Fund cannot enter into such a transaction, it may be required to hold a
security or currency that it might otherwise have sold. When the Fund writes
a covered call option, it runs the risk of not being able to participate in
the appreciation of the underlying securities or currencies above the
exercise price, as well as the risk of being required to hold on to
securities or currencies that are depreciating in value. This could result in
higher transaction costs. The Fund will pay transaction costs in connection
with the writing of options to close out previously written options. Such
transaction costs are normally higher than those applicable to purchases and
sales of portfolio securities.
Call options written by the Fund will normally have expiration dates of less
than nine months from the date written. The exercise price of the options may
be below, equal to, or above the current market values of the underlying
securities or currencies at the time the options are written. From time to
time, the Fund may purchase an underlying security or currency for delivery
in accordance with an exercise notice of a call option assigned to it, rather
than delivering such security or currency from its portfolio. In such cases,
additional costs may be incurred.
The Fund will realize a profit or loss from a closing purchase transaction if
the cost of the transaction is less or more than the premium received from
the writing of the option. Because increases in the market price of a call
option will generally reflect increases in the market price of the underlying
security or currency, any loss resulting from the repurchase of a call option
is likely to be offset in whole or in part by appreciation of the underlying
security or currency owned by the Fund.
The Fund will not write a covered call option if, as a result, the aggregate
market value of all portfolio securities or currencies covering written call
or put options exceeds 25% of the market value of the Fund's net assets. In
calculating the 25% limit, the Fund will offset, against the value of assets
covering written calls and puts, the value of purchased calls and puts on
identical securities or currencies with identical maturity dates.
Writing Covered Put Options
The Fund may write American or European style covered put options and
purchase options to close out options previously written by the Fund. A put
option gives the purchaser of the option the right to sell, and the writer
(seller) has the obligation to buy, the underlying security or currency at
the exercise price during the option period (American style) or at the
expiration of the option (European style). So long as the obligation of the
writer continues, he may be assigned an exercise notice by the broker-dealer
through whom such option was sold, requiring him to make payment to the
exercise price against delivery of the underlying security or currency. The
operation of put options in other respects, including their related risks and
rewards, is substantially identical to that of call options.
The Fund would write put options only on a covered basis, which means that
the Fund would maintain in a segregated account cash, U.S. government
securities, other liquid high-grade debt obligations, or other suitable cover
as determined by the SEC, in an amount not less than the exercise price or
the Fund will own an option to sell the underlying security or currency
subject to the option having an exercise price equal to or greater than the
exercise price of the "covered" option at all times while the put option is
outstanding. (The rules of a clearing corporation currently require that such
assets be deposited in escrow to secure payment of the exercise price.)
The Fund would generally write covered put options in circumstances where T.
Rowe Price wishes to purchase the underlying security or currency for the
Fund's portfolio at a price lower than the current market price of the
security or currency. In such event the Fund would write a put option at an
exercise price which, reduced by the premium received on the option, reflects
the lower price it is willing to pay. Since the Fund would also receive
interest on debt securities or currencies maintained to cover the exercise
price of the option, this technique could be used to enhance current return
during periods of market uncertainty. The risk in such a transaction would be
that the market price of the underlying security or currency would decline
below the exercise price less the premiums received. Such a decline could be
substantial and result in a significant loss to the Fund. In addition, the
Fund, because it does not own the specific securities or
<PAGE>
currencies which it may be required to purchase in exercise of the put,
cannot benefit from appreciation, if any, with respect to such specific
securities or currencies.
The Fund will not write a covered put option if, as a result, the aggregate
market value of all portfolio securities or currencies covering put or call
options exceeds 25% of the market value of the Fund's net assets. In
calculating the 25% limit, the Fund will offset, against the value of assets
covering written puts and calls, the value of purchased puts and calls on
identical securities or currencies with identical maturity dates.
Purchasing Put Options
The Fund may purchase American or European style put options. As the holder
of a put option, the Fund has the right to sell the underlying security or
currency at the exercise price at any time during the option period (American
style) or at the expiration of the option (European style). The Fund may
enter into closing sale transactions with respect to such options, exercise
them or permit them to expire. The Fund may purchase put options for
defensive purposes in order to protect against an anticipated decline in the
value of its securities or currencies. An example of such use of put options
is provided next.
The Fund may purchase a put option on an underlying security or currency (a
"protective put") owned by the Fund as a defensive technique in order to
protect against an anticipated decline in the value of the security or
currency. Such hedge protection is provided only during the life of the put
option when the Fund, as the holder of the put option, is able to sell the
underlying security or currency at the put exercise price regardless of any
decline in the underlying security's market price or currency's exchange
value. For example, a put option may be purchased in order to protect
unrealized appreciation of a security or currency where T. Rowe Price deems
it desirable to continue to hold the security or currency because of tax
considerations. The premium paid for the put option and any transaction costs
would reduce any capital gain otherwise available for distribution when the
security or currency is eventually sold.
The Fund may also purchase put options at a time when the Fund does not own
the underlying security or currency. By purchasing put options on a security
or currency it does not own, the Fund seeks to benefit from a decline in the
market price of the underlying security or currency. If the put option is not
sold when it has remaining value, and if the market price of the underlying
security or currency remains equal to or greater than the exercise price
during the life of the put option, the Fund will lose its entire investment
in the put option. In order for the purchase of a put option to be
profitable, the market price of the underlying security or currency must
decline sufficiently below the exercise price to cover the premium and
transaction costs, unless the put option is sold in a closing sale
transaction.
The Fund will not commit more than 5% of its assets to premiums when
purchasing put and call options. The premium paid by the Fund when purchasing
a put option will be recorded as an asset of the Fund. This asset will be
adjusted daily to the option's current market value, which will be the latest
sale price at the time at which the net asset value per share of the Fund is
computed (close of New York Stock Exchange), or, in the absence of such sale,
the latest bid price. This asset will be terminated upon expiration of the
option, the selling (writing) of an identical option in a closing
transaction, or the delivery of the underlying security or currency upon the
exercise of the option.
Purchasing Call Options
The Fund may purchase American or European style call options. As the holder
of a call option, the Fund has the right to purchase the underlying security
or currency at the exercise price at any time during the option period
(American style) or at the expiration of the option (European style). The
Fund may enter into closing sale transactions with respect to such options,
exercise them or permit them to expire. The Fund may purchase call options
for the purpose of increasing its current return or avoiding tax consequences
which could reduce its current return. The Fund may also purchase call
options in order to acquire the underlying securities or currencies. Examples
of such uses of call options are provided next.
Call options may be purchased by the Fund for the purpose of acquiring the
underlying securities or currencies for its portfolio. Utilized in this
fashion, the purchase of call options enables the Fund to acquire the
securities or currencies at the exercise price of the call option plus the
premium paid. At times the net cost
<PAGE>
of acquiring securities or currencies in this manner may be less than the
cost of acquiring the securities or currencies directly. This technique may
also be useful to the Fund in purchasing a large block of securities or
currencies that would be more difficult to acquire by direct market
purchases. So long as it holds such a call option rather than the underlying
security or currency itself, the Fund is partially protected from any
unexpected decline in the market price of the underlying security or currency
and in such event could allow the call option to expire, incurring a loss
only to the extent of the premium paid for the option.
The Fund will not commit more than 5% of its assets to premiums when
purchasing call and put options. The Fund may also purchase call options on
underlying securities or currencies it owns in order to protect unrealized
gains on call options previously written by it. A call option would be
purchased for this purpose where tax considerations make it inadvisable to
realize such gains through a closing purchase transaction. Call options may
also be purchased at times to avoid realizing losses.
Dealer (Over-the-Counter) Options
The Fund may engage in transactions involving dealer options. Certain risks
are specific to dealer options. While the Fund would look to a clearing
corporation to exercise exchange-traded options, if the Fund were to purchase
a dealer option, it would rely on the dealer from whom it purchased the
option to perform if the option were exercised. Failure by the dealer to do
so would result in the loss of the premium paid by the Fund as well as loss
of the expected benefit of the transaction.
Exchange-traded options generally have a continuous liquid market while
dealer options have none. Consequently, the Fund will generally be able to
realize the value of a dealer option it has purchased only by exercising it
or reselling it to the dealer who issued it. Similarly, when the Fund writes
a dealer option, it generally will be able to close out the option prior to
its expiration only by entering into a closing purchase transaction with the
dealer to which the Fund originally wrote the option. While the Fund will
seek to enter into dealer options only with dealers who will agree to and
which are expected to be capable of entering into closing transactions with
the Fund, there can be no assurance that the Fund will be able to liquidate a
dealer option at a favorable price at any time prior to expiration. Until the
Fund, as a covered dealer call option writer, is able to effect a closing
purchase transaction, it will not be able to liquidate securities (or other
assets) or currencies used as cover until the option expires or is exercised.
In the event of insolvency of the contra party, the Fund may be unable to
liquidate a dealer option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in material losses
to the Fund. For example, since the Fund must maintain a secured position
with respect to any call option on a security it writes, the Fund may not
sell the assets which it has segregated to secure the position while it is
obligated under the option. This requirement may impair a Fund's ability to
sell portfolio securities or currencies at a time when such sale might be
advantageous.
The Staff of the SEC has taken the position that purchased dealer options and
the assets used to secure the written dealer options are illiquid securities.
The Fund may treat the cover used for written OTC options as liquid if the
dealer agrees that the Fund may repurchase the OTC option it has written for
a maximum price to be calculated by a predetermined formula. In such cases,
the OTC option would be considered illiquid only to the extent the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
Lending of Portfolio Securities
Securities loans are made to broker-dealers or institutional investors or
other persons, pursuant to agreements requiring that the loans be
continuously secured by collateral at least equal at all times to the value
of the securities lent, marked to market on a daily basis. The collateral
received will consist of cash, U.S. government securities, letters of credit
or such other collateral as may be permitted under its investment program.
While the securities are being lent, the Fund will continue to receive the
equivalent of the interest or dividends paid by the issuer on the securities,
as well as interest on the investment of the collateral or a fee from the
borrower. The Fund has a right to call each loan and obtain the securities,
within such period of time which coincides with the normal settlement period
for purchases and sales of such securities in the respective markets. The
Fund will not have the right to vote on securities while they are being lent,
but it will call a loan in anticipation of any important vote. The risks in
lending portfolio securities, as with other
<PAGE>
extensions of secured credit, consist of possible delay in receiving
additional collateral or in the recovery of the securities or possible loss
of rights in the collateral should the borrower fail financially. Loans will
only be made to firms deemed by T. Rowe Price to be of good standing and will
not be made unless, in the judgment of T. Rowe Price, the consideration to be
earned from such loans would justify the risk.
Repurchase Agreements
The Fund may enter into a repurchase agreement through which an investor
(such as the Fund) purchases a security (known as the "underlying security")
from a well-established securities dealer or a bank that is a member of the
Federal Reserve System. Any such dealer or bank will be on T. Rowe Price's
approved list and have a credit rating with respect to its short-term debt of
at least A1 by Standard & Poor's Corporation, P1 by Moody's Investors
Services, Inc., or the equivalent rating by T. Rowe Price. At that time, the
bank or securities dealer agrees to repurchase the underlying security at the
same price, plus specified interest. Repurchase agreements are generally for
a short period of time, often less than a week. Repurchase agreements which
do not provide for payment within seven days will be treated as illiquid
securities. The Fund will only enter into repurchase agreements where (i) the
underlying securities are of the type (excluding maturity limitations) which
the Fund's investment guidelines would allow it to purchase directly, (ii)
the market value of the underlying security, including interest accrued, will
be at all times equal to or exceed the value of the repurchase agreement, and
(iii) payment for the underlying security is made only upon physical delivery
or evidence of book-entry transfer to the account of the custodian or a bank
acting as agent. In the event of a bankruptcy or other default of a seller of
a repurchase agreement, the Fund could experience both delays in liquidating
the underlying security and losses, including: (a) possible decline in the
value of the underlying security during the period while the Fund seeks to
enforce its rights thereto; (b) possible subnormal levels of income and lack
of access to income during this period; and (c) expenses of enforcing its
rights.
Reverse Repurchase Agreements
Although the Fund has no current intention of engaging in reverse repurchase
agreements, the Fund reserves the right to do so. Reverse repurchase
agreements are ordinary repurchase agreements in which a Fund is the seller
of, rather than the investor in, securities, and agrees to repurchase them at
an agreed upon time and price. Use of a reverse repurchase agreement may be
preferable to a regular sale and later repurchase of the securities because
it avoids certain market risks and transaction costs. A reverse repurchase
agreement may be viewed as a type of borrowing by the Fund, subject to
Investment Restriction (1). (See "Investment Restrictions.")
All Funds
INVESTMENT RESTRICTIONS
-------------------------------------------------------------------------------
Fundamental policies may not be changed without the approval of the lesser of
(1) 67% of the Fund's shares present at a meeting of shareholders if the
holders of more than 50% of the outstanding shares are present in person or
by proxy or (2) more than 50% of a Fund's outstanding shares. Other
restrictions in the form of operating policies are subject to change by the
Fund's Board of Directors/Trustees without shareholder approval. Any
investment restriction which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after, and is caused by, an acquisition of
securities or assets of, or borrowings by, the Fund. Calculation of the
Fund's total assets for compliance with any of the following fundamental or
operating policies or any other investment restrictions set forth in the
Fund's prospectus or Statement of Additional Information will not include
cash collateral held in connection with securities lending activities.
Fundamental Policies
As a matter of fundamental policy, the Fund may not:
(1) Borrowing Borrow money except that the Fund may (i) borrow for
non-leveraging, temporary or emergency purposes; and (ii) engage in
reverse repurchase agreements and make other investments or engage in
other transactions, which may involve a borrowing, in a manner consistent
with the Fund's
<PAGE>
investment objective and program, provided that the combination of (i)
and (ii) shall not exceed 33/1//\\/3/\\% of the value of the Fund's total
assets (including the amount borrowed) less liabilities (other than
borrowings) or such other percentage permitted by law. Any borrowings
which come to exceed this amount will be reduced in accordance with
applicable law. The Fund may borrow from banks, other Price Funds, or
other persons to the extent permitted by applicable law;
(2) Commodities Purchase or sell physical commodities; except that the Fund
(other than the Money Funds) may enter into futures contracts and options
thereon;
(3) Industry Concentration Purchase the securities of any issuer if, as a
result, more than 25% of the value of the Fund's total assets would be
invested in the securities of issuers having their principal business
activities in the same industry;
(4) Loans Make loans, although the Fund may (i) lend portfolio securities and
participate in an interfund lending program with other Price Funds
provided that no such loan may be made if, as a result, the aggregate of
such loans would exceed 33/1//\\/3/\\% of the value of the Fund's total
assets; (ii) purchase money market securities and enter into repurchase
agreements; and (iii) acquire publicly distributed or privately placed
debt securities and purchase debt;
(5) Percent Limit on Assets Invested in Any One Issuer (National and
California Funds Only) Purchase a security if, as a result, with respect
to 75% of the value of its total assets, more than 5% of the value of the
Fund's total assets would be invested in the securities of a single
issuer, except securities issued or guaranteed by the U.S. government or
any of its agencies or instrumentalities;
(6) Percent Limit on Share Ownership of Any One Issuer (National and
California Funds Only) Purchase a security if, as a result, with respect
to 75% of the value of the Fund's total assets, more than 10% of the
outstanding voting securities of any issuer would be held by the Fund
(other than obligations issued or guaranteed by the U.S. government, its
agencies or instrumentalities);
(7) Real Estate Purchase or sell real estate, including limited partnership
interests therein, unless acquired as a result of ownership of securities
or other instruments (but this shall not prevent the Fund from investing
in securities or other instruments backed by real estate or securities of
companies engaged in the real estate business);
(8) Senior Securities Issue senior securities except in compliance with the
1940 Act;
(9) Taxable Securities (All Funds, except Tax-Efficient Balanced) During
periods of normal market conditions, purchase any security if, as a
result, less than 80% of the Fund's income would be exempt from federal,
and if applicable, any state, city, or local income tax. The income
included under the 80% test doesn't include income from securities
subject to the alternative minimum tax (AMT); or
(10) Underwriting Underwrite securities issued by other persons, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase and
sale of its portfolio securities in the ordinary course of pursuing its
investment program.
NOTES
The following Notes should be read in connection with the above-described
fundamental policies. The Notes are not fundamental policies.
With respect to investment restrictions (1) and (4), the Fund will not
borrow from or lend to any other Price Fund (defined as any other mutual
fund managed by or for which T. Rowe Price or Price-Fleming acts as
adviser) unless each Fund applies for and receives an exemptive order
from the SEC or the SEC issues rules permitting such transactions. There
is no assurance the SEC would grant any order requested by the Fund or
promulgate any rules allowing the transactions.
With respect to investment restriction (1), the Money Funds have no
current intention of engaging in any borrowing transactions.
<PAGE>
With respect to investment restriction (2), the Fund does not consider
currency contracts or hybrid investments to be commodities.
For purposes of investment restriction (3), U.S., state or local
governments, or related agencies or instrumentalities, are not considered
an industry. Industries are determined by reference to the
classifications of industries set forth in the Fund's semiannual and
annual reports. It is the position of the Staff of the SEC that foreign
governments are industries for purposes of this restriction.
Operating Policies
As a matter of operating policy, the Fund may not:
(1) Borrowing Purchase additional securities when money borrowed exceeds 5%
of its total assets;
(2) Control of Portfolio Companies Invest in companies for the purpose of
exercising management or control;
(3) Equity Securities (All Funds except Tax-Efficient Balanced Fund) Purchase
any equity security or security convertible into an equity security
provided that the Fund (other than the Money Funds) may invest up to 10%
of its total assets in equity securities which pay tax-exempt dividends
and which are otherwise consistent with the Fund's investment objective
and, further provided, that the Money Funds may invest up to 10% of its
total assets in equity securities of other tax-free open-end money market
funds;
(4) Futures Contracts Purchase a futures contract or an option thereon, if,
with respect to positions in futures or options on futures which do not
represent bona fide hedging, the aggregate initial margin and premiums on
such options would exceed 5% of the Fund's net asset value;
(5) Illiquid Securities Purchase illiquid securities if, as a result, more
than 15% (10% for Money Funds) of its net assets would be invested in
such securities;
(6) Investment Companies Purchase securities of open-end or closed-end
investment companies except (i) in compliance with the Investment Company
Act of 1940; (ii) in the case of the Tax-Free Funds, only securities of
other tax-free money market funds; or (iii) in the case of Tax-Efficient
Balanced Fund, securities of the Reserve Investment or Government Reserve
Investment Funds;
(7) Margin Purchase securities on margin, except (i) for use of short-term
credit necessary for clearance of purchases of portfolio securities and
(ii) it may make margin deposits in connection with futures contracts or
other permissible investments;
(8) Mortgaging Mortgage, pledge, hypothecate or, in any manner, transfer any
security owned by the Fund as security for indebtedness except as may be
necessary in connection with permissible borrowings or investments and
then such mortgaging, pledging or hypothecating may not exceed
33/1//\\/3/\\% of the Fund's total assets at the time of borrowing or
investment;
(9) Oil and Gas Programs Purchase participations or other direct interests
in, or enter into leases with respect to oil, gas, or other mineral
exploration or development programs if, as a result thereof, more than 5%
of the value of the total assets of the Fund would be invested in such
programs;
(10) Options, etc. Invest in puts, calls, straddles, spreads, or any
combination thereof, except to the extent permitted by the prospectus and
Statement of Additional Information;
(11) Short Sales Effect short sales of securities; or
(12) Warrants Invest in warrants if, as a result thereof, more than 2% (for
the Summit Income Funds) or 2% (for the Summit Municipal Funds) of the
value of the net assets of the Fund would be invested in warrants.
With respect to investment restriction (6), the Funds have no current
intention of purchasing the securities of other investment companies.
Duplicate fees could result from any such purchases.
<PAGE>
MANAGEMENT OF THE FUNDS
-------------------------------------------------------------------------------
The officers and directors/trustees of the Fund are listed below. Unless
otherwise noted, the address of each is 100 East Pratt Street, Baltimore,
Maryland 21202. Except as indicated, each has been an employee of T. Rowe
Price for more than five years. In the list below, the Fund's
directors/trustees who are considered "interested persons" of T. Rowe Price
as defined under Section 2(a)(19) of the Investment Company Act of 1940 are
noted with an asterisk (*). These directors/trustees are referred to as
inside directors by virtue of their officership, directorship, and/or
employment with T. Rowe Price.
Independent Directors/Trustees
All Funds except Tax-Efficient Balanced Fund
CALVIN W. BURNETT, PH.D., President, Coppin State College; Director, Maryland
Chamber of Commerce and Provident Bank of Maryland; Former President,
Baltimore Area Council Boy Scouts of America; Vice President, Board of
Directors, The Walters Art Gallery; Address: 2500 West North Avenue,
Baltimore, Maryland 21216
ANTHONY W. DEERING, Director, Chairman of the Board, President and Chief
Operating Officer, The Rouse Company, real estate developers, Columbia,
Maryland; Advisory Director, Kleinwort, Benson (North America) Corporation, a
registered broker-dealer; Address: 10275 Little Patuxent Parkway, Columbia,
Maryland 21044
F. PIERCE LINAWEAVER, President, F. Pierce Linaweaver & Associates, Inc.;
Consulting Environmental & Civil Engineer(s); formerly Executive Vice
President, EA Engineering, Science, and Technology, Inc., and President, EA
Engineering, Inc., Baltimore, Maryland; Address: Green Spring Station, 2360
West Joppa Road, Suite 224, Lutherville, Maryland 21093
JOHN G. SCHREIBER, President, Schreiber Investments, Inc., a real estate
investment company; Director, AMLI Residential Properties Trust and Urban
Shopping Centers, Inc.; Partner, Blackstone Real Estate Partners, L.P.;
Director and formerly Executive Vice President, JMB Realty Corporation, a
national real estate investment manager and developer; Address: 1115 East
Illinois Road, Lake Forest, Illinois 60045
Tax-Efficient Balanced Fund
DONALD W. DICK, JR., Principal, EuroCapital Advisors, LLC, an acquisition and
management advisory firm; formerly (5/89-6/95) Principal, Overseas Partners,
Inc., a financial investment firm; formerly (6/65-3/89) Director and Vice
President; Consumer Products Division, McCormick & Company, Inc.,
international food processors; Director, Waverly, Inc., Baltimore, Maryland;
Address: P.O. Box 491, Chilmark, MA 02535-0491
DAVID K. FAGIN, Chairman and Chief Executive Officer, Western Exploration and
Development, Ltd.; Director Golden Star Resources Ltd. and Miranda Mining
Development Corporation; formerly (1986-7/91) President, Chief Operating
Officer and Director, Homestake Mining Company; Address: 1660 Lincoln Street,
Suite 3000, Denver, Colorado 80264-3001
HANNE M. MERRIMAN, Retail business consultant; formerly President and Chief
Operating Officer (1991-92), Nan Duskin, Inc., a women's specialty store,
Director (1984-90) and Chairman (1989-90) Federal Reserve Bank of Richmond,
and President and Chief Executive Officer (1988-89), Honeybee, Inc., a
division of Spiegel, Inc.; Director, Central Illinois Public Service Company,
CIPSCO Incorporated, Finlay Enterprises, Inc., The Rouse Company, State Farm
Mutual Automobile Insurance Company and USAir Group, Inc.; Address: 3201 New
Mexico Avenue, N.W., Suite 350, Washington, D.C. 20016
HUBERT D. VOS, President, Stonington Capital Corporation, a private
investment company; Address: 1231 State Street, Suite 247, Santa Barbara,
California 93190-0409
PAUL M. WYTHES, Founding General Partner, Sutter Hill Ventures, a venture
capital limited partnership, providing equity capital to young high
technology companies throughout the United States; Director, Teltone
Corporation, Interventional Technologies Inc. and Stuart Medical, Inc.;
Address: 755 Page Mill Road, Suite A200, Palo Alto, California 94304-1005
<PAGE>
Officers
HENRY H. HOPKINS, Vice President-Vice President, Price-Fleming and T. Rowe
Price Retirement Plan Services, Inc.; Director and Managing Director, T. Rowe
Price; Vice President and Director, T. Rowe Price Investment Services, Inc.,
T. Rowe Price Services, Inc. and T. Rowe Price Trust Company
PATRICIA S. LIPPERT, Secretary-Assistant Vice President, T. Rowe Price and T.
Rowe Price Investment Services, Inc.
CARMEN F. DEYESU, Treasurer-Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
DAVID S. MIDDLETON, Controller-Vice President, T. Rowe Price, T. Rowe Price
Services, Inc., and T. Rowe Price Trust Company
INGRID I. VORDEMBERGE, Assistant Vice President-Employee, T. Rowe Price
California and State Tax-Free Trusts
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* JAMES S. RIEPE, Trustee and Vice President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Trustee -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
MARY J. MILLER, President -Managing Director, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
JEREMY N. BAKER, Vice President -Employee, T. Rowe Price
PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price
A. GENE CAPONI, Vice President -Vice President and Analyst, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, Vice President -Vice President, T. Rowe Price
JOSEPH K. LYNAGH, Vice President -Assistant Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President -Assistant Vice President, T. Rowe
Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, Vice President -Vice President, T. Rowe Price
State Tax-Free Trust Only
MARCY M. LASH, Vice President -Assistant Vice President and Municipal Credit
Analyst, T. Rowe Price; (1998) formerly Assistant Vice President,
underwriting, at Connie Lee Insurance Company
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
GWENDOLYN G. WAGNER, Vice President -Vice President and Economist, T. Rowe
Price; Chartered Financial Analyst
<PAGE>
ROBERT A. DONAHUE, Assistant Vice President -Municipal Credit Analyst, T.
Rowe Price; (1998) formerly Director of Policy Evaluation, District of
Columbia Public Schools
JULIE A. SALSBERY, Assistant Vice President -Fixed Income Trader, T. Rowe
Price; (1997) formerly assistant portfolio manager/trader at Wainwright Asset
Management
Tax-Efficient Balanced Fund
* JAMES A.C. KENNEDY III, Director and Vice President -Managing Director, T.
Rowe Price; Chartered Financial Analyst
* JAMES S. RIEPE, Director and President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
MARY J. MILLER, Executive Vice President -Managing Director, T. Rowe Price
DONALD J. PETERS, Executive Vice President -Vice President, T. Rowe Price;
formerly portfolio manager, Geewax Terker and Company
STEPHEN W. BOESEL, Vice President -Managing Director, T. Rowe Price
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
WILLIAM T. REYNOLDS, Vice President -Managing Director, T. Rowe Price;
Chartered Financial Analyst
WILLIAM F. SNIDER, Vice President -Vice President, T. Rowe Price
WILLIAM J. STROMBERG, Vice President -Vice President, T. Rowe Price;
Chartered Financial Analyst
ARTHUR S. VARNADO, Vice President -Vice President, T. Rowe Price
J. JEFFREY LANG, Assistant Vice President-Assistant Vice President, T. Rowe
Price
Tax-Exempt Money Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* JAMES S. RIEPE, Director and Vice President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
PATRICE BERCHTENBREITER ELY, President -Vice President, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
JEREMY N. BAKER, Vice President -Employee, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
JOSEPH K. LYNAGH, Vice President -Assistant Vice President, T. Rowe Price
MARY J. MILLER, Vice President -Managing Director, T. Rowe Price
<PAGE>
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, Vice President -Vice President, T. Rowe Price
Tax-Free High Yield Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* JAMES S. RIEPE, Director and Vice President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
C. STEPHEN WOLFE II, Vice President -Vice President, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
A. GENE CAPONI, Vice President -Vice President and Analyst, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, Vice President -Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President -Assistant Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
MARY J. MILLER, Vice President -Managing Director, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, Vice President -Vice President, T. Rowe Price
Tax-Free Income Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* JAMES S. RIEPE, Director and Vice President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
MARY J. MILLER, President -Managing Director, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, Executive Vice President -Vice President, T.
Rowe Price
A. GENE CAPONI, Vice President -Vice President and Analyst, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
CHARLES B. HILL, Vice President -Vice President, T. Rowe Price
MARCY M. LASH, Vice President -Assistant Vice President and Municipal Credit
Analyst, T. Rowe Price; (1998) formerly Assistant Vice President,
underwriting, at Connie Lee Insurance Company
<PAGE>
KONSTANTINE B. MALLAS, Vice President -Assistant Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, Vice President -Vice President, T. Rowe Price
Tax-Free Intermediate Bond Fund
* WILLIAM T. REYNOLDS, Director -Managing Director, T. Rowe Price; Chartered
Financial Analyst
* JAMES S. RIEPE, Director -Vice Chairman of the Board and Managing Director,
T. Rowe Price; Chairman of the Board, T. Rowe Price Investment Services,
Inc., T. Rowe Price Services, Inc., T. Rowe Price Retirement Plan Services,
Inc., and T. Rowe Price Trust Company; Director, Price-Fleming and General Re
Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
CHARLES B. HILL, President -Vice President, T. Rowe Price
MARY J. MILLER, Executive Vice President -Managing Director, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
KONSTANTINE B. MALLAS, Vice President -Assistant Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
WILLIAM F. SNIDER, Vice President -Vice President, T. Rowe Price
ROBERT A. DONAHUE, Assistant Vice President -Municipal Credit Analyst, T.
Rowe Price; (1998) formerly Director of Policy Evaluation, District of
Columbia Public Schools
JULIE A. SALSBERY, Assistant Vice President -Fixed Income Trader, T. Rowe
Price; (1997) formerly assistant portfolio manager/trader at Wainwright Asset
Management
Tax-Free Short-Intermediate Fund
* WILLIAM T. REYNOLDS, Chairman of the Board -Managing Director, T. Rowe
Price; Chartered Financial Analyst
* JAMES S. RIEPE, Director and Vice President -Vice Chairman of the Board and
Managing Director, T. Rowe Price; Chairman of the Board, T. Rowe Price
Investment Services, Inc., T. Rowe Price Services, Inc., T. Rowe Price
Retirement Plan Services, Inc., and T. Rowe Price Trust Company; Director,
Price-Fleming and General Re Corporation
* M. DAVID TESTA, Director -Chairman of the Board, Price-Fleming; Vice
Chairman of the Board, Chief Investment Officer, and Managing Director, T.
Rowe Price; Vice President and Director, T. Rowe Price Trust Company;
Chartered Financial Analyst
MARY J. MILLER, President -Managing Director, T. Rowe Price
CHARLES B. HILL, Executive Vice President -Vice President, T. Rowe Price
JANET G. ALBRIGHT, Vice President -Vice President, T. Rowe Price
PATRICE BERCHTENBREITER ELY, Vice President -Vice President, T. Rowe Price
PATRICIA S. DEFORD, Vice President -Vice President, T. Rowe Price
<PAGE>
KONSTANTINE B. MALLAS, Vice President -Assistant Vice President, T. Rowe
Price
HUGH D. MCGUIRK, Vice President -Assistant Vice President, T. Rowe Price
EDWARD T. SCHNEIDER, Vice President -Vice President, T. Rowe Price
C. STEPHEN WOLFE II, Vice President -Vice President, T. Rowe Price
JULIE A. SALSBERY, Assistant Vice President -Fixed Income Trader, T. Rowe
Price; (1997) formerly assistant portfolio manager/trader at Wainwright Asset
Management
Compensation Table
The Funds do not pay pension or retirement benefits to their officers or
directors/trustees. Also, any director/ trustee of a Fund who is an officer
or employee of T. Rowe Price or Price-Fleming does not receive any
remuneration from the Fund.
<TABLE>
<CAPTION>
Name of Person, Aggregate Compensation from Fund(a) Total Compensation from Fund and Fund Complex
Position ------- Paid to Directors/ Trustees(b)
- --------------------------- -----------
- ------------------------------------------------------------------
--------------------------------------------------------------------------
----------------------------------------------
<S> <S> <S>
California Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,303 $65,000
Calvin W. Burnett, Trustee 1,303 65,000
Anthony W. Deering, Trustee 1,115 81,000
F. Pierce Linaweaver, Trustee 1,303 66,000
John G. Schriber, Trustee 1,303 65,500
- --------------------------------------------------------------------------------------------------------------------------
California Tax-Free Money Fund
Robert P. Black, Trustee(c) $1,145 $65,000
Calvin W. Burnett, Trustee 1,145 65,000
Anthony W. Deering, Trustee 1,051 81,000
F. Pierce Linaweaver, Trustee 1,145 66,000
John G. Schriber, Trustee 1,145 65,500
- --------------------------------------------------------------------------------------------------------------------------
Florida Intermediate Tax-Free Fund
Robert P. Black, Trustee(c) $1,139 $65,000
Calvin W. Burnett, Trustee 1,139 65,000
Anthony W. Deering, Trustee 1,048 81,000
F. Pierce Linaweaver, Trustee 1,139 66,000
John G. Schriber, Trustee 1,139 65,500
- --------------------------------------------------------------------------------------------------------------------------
Georgia Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,070 $65,000
Calvin W. Burnett, Trustee 1,070 65,000
Anthony W. Deering, Trustee 1,024 81,000
F. Pierce Linaweaver, Trustee 1,070 66,000
John G. Schriber, Trustee 1,070 65,500
- --------------------------------------------------------------------------------------------------------------------------
Maryland Short-Term Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,182 $65,000
Calvin W. Burnett, Trustee 1,182 65,000
Anthony W. Deering, Trustee 1,068 81,000
F. Pierce Linaweaver, Trustee 1,182 66,000
John G. Schriber, Trustee 1,182 65,500
- --------------------------------------------------------------------------------------------------------------------------
Maryland Tax-Free Bond Fund
Robert P. Black, Trustee(c) $2,508 $65,000
Calvin W. Burnett, Trustee 2,508 65,000
Anthony W. Deering, Trustee 1,579 81,000
F. Pierce Linaweaver, Trustee 2,508 66,000
John G. Schriber, Trustee 2,508 65,500
- --------------------------------------------------------------------------------------------------------------------------
New Jersey Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,141 $65,000
Calvin W. Burnett, Trustee 1,141 65,000
Anthony W. Deering, Trustee 1,056 81,000
F. Pierce Linaweaver, Trustee 1,141 66,000
John G. Schriber, Trustee 1,141 65,500
- --------------------------------------------------------------------------------------------------------------------------
New York Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,270 $65,000
Calvin W. Burnett, Trustee 1,270 65,000
Anthony W. Deering, Trustee 1,093 81,000
F. Pierce Linaweaver, Trustee 1,270 66,000
John G. Schriber, Trustee 1,270 65,500
- --------------------------------------------------------------------------------------------------------------------------
New York Tax-Free Money Fund
Robert P. Black, Trustee(c) $1,151 $65,000
Calvin W. Burnett, Trustee 1,151 65,000
Anthony W. Deering, Trustee 1,051 81,000
F. Pierce Linaweaver, Trustee 1,151 66,000
John G. Schriber, Trustee 1,151 65,500
- --------------------------------------------------------------------------------------------------------------------------
Virginia Short-Term Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,560 $65,000
Calvin W. Burnett, Trustee 1,560 65,000
Anthony W. Deering, Trustee 1,219 81,000
F. Pierce Linaweaver, Trustee 1,560 66,000
John G. Schriber, Trustee 1,560 65,500
- --------------------------------------------------------------------------------------------------------------------------
Virginia Tax-Free Bond Fund
Robert P. Black, Trustee(c) $1,665 $65,000
Calvin W. Burnett, Trustee 1,665 65,000
Anthony W. Deering, Trustee 1,271 81,000
F. Pierce Linaweaver, Trustee 1,665 66,000
John G. Schriber, Trustee 1,665 65,500
- --------------------------------------------------------------------------------------------------------------------------
Tax-Efficient Balanced Fund(d)
Donald W. Dick, Jr., Director(c) $549 $81,000
David K. Fagin, Director 741 65,000
Hanne M. Merriman, Director 741 65,000
Hubert D. Vos, Director 741 66,000
Paul M. Wythes, Director 549 80,000
- --------------------------------------------------------------------------------------------------------------------------
Tax-Exempt Money Fund
Robert P. Black, Director(c) $2,973 $65,000
Calvin W. Burnett, Director 2,973 65,000
Anthony W. Deering, Director 1,763 81,000
F. Pierce Linaweaver, Director 2,973 66,000
John G. Schriber, Director 2,973 65,500
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free High Yield Fund
Robert P. Black, Director(c) $3,390 $65,000
Calvin W. Burnett, Director 3,390 65,000
Anthony W. Deering, Director 1,920 81,000
F. Pierce Linaweaver, Director 3,390 66,000
John G. Schriber, Director 3,390 65,500
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Income Fund
Robert P. Black, Director(c) $1,770 $65,000
Calvin W. Burnett, Director 1,770 65,000
Anthony W. Deering, Director 1,295 81,000
F. Pierce Linaweaver, Director 1,770 66,000
John G. Schriber, Director 1,770 65,500
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Intermediate Bond Fund
Robert P. Black, Director(c) $1,166 $65,000
Calvin W. Burnett, Director 1,166 65,000
Anthony W. Deering, Director 1,057 81,000
F. Pierce Linaweaver, Director 1,166 66,000
John G. Schriber, Director 1,166 65,500
- --------------------------------------------------------------------------------------------------------------------------
Tax-Free Short-Intermediate Fund
Robert P. Black, Director(c) $1,179 $65,000
Calvin W. Burnett, Director 1,179 65,000
Anthony W. Deering, Director 1,068 81,000
F. Pierce Linaweaver, Director 1,179 66,000
John G. Schriber, Director 1,179 65,500
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<PAGE>
(a) Amounts in this column are based on accrued compensation from March 1,
1997 to February 28, 1998.
(b) Amounts in this column are based on compensation received from January
1, 1997, to December 31, 1997. The T. Rowe Price complex included 84 funds
as of December 31, 1997.
(c) Mr. Black retired from his position with the Funds in April 1998.
(d) Expenses accrued from June 30, 1997 to February 28, 1998.
All Funds
The Fund's Executive Committee, consisting of the Fund's interested
directors/trustees, has been authorized by its respective Board of
Directors/Trustees to exercise all powers of the Board to manage the Funds in
the intervals between meetings of the Board, except the powers prohibited by
statute from being delegated.
<PAGE>
PRINCIPAL HOLDERS OF SECURITIES
-------------------------------------------------------------------------------
As of the date of the prospectus, the officers and directors/trustees of the
Fund, as a group, owned less than 1% of the outstanding shares of the Fund.
As of June 1, 1998, the following shareholders beneficially owned more than
5% of the outstanding shares of:
California Tax-Free Money Fund: Boone & Associates, Purity Adr Settlement
Escrow, 901 Corporate Center Drive, Suite 204, Monterey Park, California
91754-7630.
New York Tax-Free Money Fund: Coleman M. Brandt and Grace L. Brandt JT TEN,
330 West 72nd Street, Apt. 10A, New York, New York 10023-2649.
Tax-Efficient Balanced Fund: Agnes T. Corigliano and Cosmo Corigliano JT TEN,
243 Stamford Avenue, Stamford, Connecticut 06902-8202.
INVESTMENT MANAGEMENT SERVICES
-------------------------------------------------------------------------------
Services
Under the Management Agreement, T. Rowe Price provides the Fund with
discretionary investment services. Specifically, T. Rowe Price is responsible
for supervising and directing the investments of the Fund in accordance with
the Fund's investment objectives, program, and restrictions as provided in
its prospectus and this Statement of Additional Information. T. Rowe Price is
also responsible for effecting all security transactions on behalf of the
Fund, including the negotiation of commissions and the allocation of
principal business and portfolio brokerage. In addition to these services, T.
Rowe Price provides the Fund with certain corporate administrative services,
including: maintaining the Fund's corporate existence and corporate records;
registering and qualifying Fund shares under federal laws; monitoring the
financial, accounting, and administrative functions of the Fund; maintaining
liaison with the agents employed by the Fund such as the Fund's custodian and
transfer agent; assisting the Fund in the coordination of such agents'
activities; and permitting T. Rowe Price's employees to serve as officers,
directors/trustees, and committee members of the Fund without cost to the
Fund.
The Management Agreement also provides that T. Rowe Price, its
directors/trustees, officers, employees, and certain other persons performing
specific functions for the Fund will only be liable to the Fund for losses
resulting from willful misfeasance, bad faith, gross negligence, or reckless
disregard of duty.
Management Fee
The Fund pays T. Rowe Price a fee ("Fee") which consists of two components: a
Group Management Fee ("Group Fee") and an Individual Fund Fee ("Fund Fee").
The Fee is paid monthly to T. Rowe Price on the first business day of the
next succeeding calendar month and is calculated as described below.
The monthly Group Fee ("Monthly Group Fee") is the sum of the daily Group Fee
accruals ("Daily Group Fee Accruals") for each month. The Daily Group Fee
Accrual for any particular day is computed by multiplying the Price Funds'
group fee accrual as determined below ("Daily Price Funds' Group Fee
Accrual") by the ratio of the Price Fund's net assets for that day to the sum
of the aggregate net assets of the Price Funds for that day. The Daily Price
Funds' Group Fee Accrual for any particular day is calculated by multiplying
the fraction of one (1) over the number of calendar days in the year by the
annualized Daily Price Funds' Group Fee Accrual for that day as determined in
accordance with the following schedule:
<PAGE>
<TABLE>
Price Funds' Annual Group Base Fee Rate for Each Level of
Assets
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
0.480% First $1 billion 0.360% Next $2 billion 0.310% Next $16
billion
---------------------------------------------------------------------------
0.450% Next $1 billion 0.350% Next $2 billion 0.305% Next $30
billion
---------------------------------------------------------------------------
0.420% Next $1 billion 0.340% Next $5 billion 0.300% Thereafter
---------------------------------------------------------------------------
0.390% Next $1 billion 0.330% Next $10 billion
---------------------------------------------------------------------------
0.370% Next $1 billion 0.320% Next $10 billion
</TABLE>
For the purpose of calculating the Group Fee, the Price Funds include all the
mutual funds distributed by T. Rowe Price Investment Services, Inc.,
(excluding the T. Rowe Price Spectrum Funds, and any institutional, index, or
private label mutual funds). For the purpose of calculating the Daily Price
Funds' Group Fee Accrual for any particular day, the net assets of each Price
Fund are determined in accordance with the Funds' prospectus as of the close
of business on the previous business day on which the Fund was open for
business.
The monthly Fund Fee ("Monthly Fund Fee") is the sum of the daily Fund Fee
accruals ("Daily Fund Fee Accruals") for each month. The Daily Fund Fee
Accrual for any particular day is computed by multiplying the fraction of one
(1) over the number of calendar days in the year by the individual Fund Fee
Rate and multiplying this product by the net assets of the Fund for that day,
as determined in accordance with the Fund's prospectus as of the close of
business on the previous business day on which the Fund was open for
business. The individual fund fees are listed in the following chart:
<TABLE>
<CAPTION>
<S> <C>
California Tax-Free Bond Fund 0.10%
California Tax-Free Money Fund 0.10
Florida Intermediate Tax-Free Fund 0.05
Georgia Tax-Free Bond Fund 0.10
Maryland Tax-Free Bond Fund 0.10
Maryland Short-Term Tax-Free Bond Fund 0.10
New Jersey Tax-Free Bond Fund 0.10
New York Tax-Free Bond Fund 0.10
New York Tax-Free Money Fund 0.10
Virginia Tax-Free Bond Fund 0.10
Virginia Short-Term Tax-Free Bond Fund 0.10
Tax-Efficient Balanced Fund 0.20
Tax-Exempt Money Fund 0.10
Tax-Free High Yield Fund 0.30
Tax-Free Income Fund 0.15
Tax-Free Intermediate Bond Fund 0.05
Tax-Free Short-Intermediate Fund 0.10
</TABLE>
The following chart sets forth the total management fees, if any, paid to T.
Rowe Price by each Fund, during the last three years:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 744,000 $ 644,000 $ 609,000
California Tax-Free Money 263,000 195,000 175,000
Florida Intermediate Tax-Free 302,000 211,000 153,000
Georgia Tax-Free Bond 108,000 41,000 13,000
Maryland Tax-Free Bond 3,659,000 3,398,000 3,352,000
Maryland Short-Term Tax-Free Bond 488,000 378,000 326,000
New Jersey Tax-Free Bond 352,000 244,000 206,000
New York Tax-Free Bond 670,000 582,000 550,000
New York Tax-Free Money 281,000 205,000 172,000
Virginia Tax-Free Bond 895,000 829,000 770,000
Virginia Short-Term Tax-Free Bond 0(a) 0(a) 0(a)
Tax-Efficient Balanced 0(a) -- --
Tax-Exempt Money 2,989,000 2,880,000 2,993,000
Tax-Free High Yield 7,051,000 6,309,000 5,968,000
Tax-Free Income 6,428,000 6,426,000 6,613,000
Tax-Free Intermediate Bond 391,000 315,000 274,000
Tax-Free Short-Intermediate 1,856,000 1,884,000 1,975,000
- --------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Due to effect of expense limitations discussed below, the Fund did
not pay T. Rowe Price an investment management fee.
(b) Prior to commencement of operations.
Limitation on Fund Expenses
The Management Agreement between the Fund and T. Rowe Price provides that the
Fund will bear all expenses of its operations not specifically assumed by T.
Rowe Price.
For the purpose of determining whether a Fund is entitled to reimbursement,
the expenses of a Fund are calculated on a monthly basis. If a Fund is
entitled to reimbursement, that month's advisory fee will be reduced or
postponed, with any adjustment made after the end of the year.
California Tax-Free Money Fund and New York Tax-Free Funds
Pursuant to the California Money Fund's present expense limitation, $99,000,
of management fees were not accrued for the year ended February 28, 1998.
Additionally, $271,000 of unaccrued management fees related to a previous
expense limitation were not accrued. Pursuant to the New York Money Fund's
present expense limitations, $94,000 of management fees were not accrued for
the year ended February 28, 1998 and $258,000 and remain unaccrued from prior
periods. Subject to shareholder approval, the expenses of both funds may be
reimbursed to T. Rowe Price, provided that the recapture of fees would not
cause the ratio of expenses to average net assets to exceed the
above-mentioned ratios.
Florida Intermediate Fund
Pursuant to the present expense limitation, $6,000 of management fees for the
Florida Fund were not accrued for the year ended February 28, 1998, and
$123,000 remains unaccrued from the prior period.
Georgia Fund
Pursuant to the present expense limitation, $78,000 of management fees were
not accrued by the Georgia Bond Fund for the year ended February 28, 1998,
and $216,000 remains unaccrued from the prior period.
Maryland Short-Term Tax-Free Bond Fund
Pursuant to a previous expense limitation, $13,000 of management fees remain
unaccrued by the Maryland Short-Term Fund for the year ended February 28,
1998.
New Jersey Fund
Pursuant to the present expense limitation, $21,000 of management fees were
not accrued by the New Jersey Fund for the year ended February 28, 1998, and
$151,000 remains unaccrued from the prior period.
<PAGE>
Virginia Short-Term Bond Fund
Pursuant to the present expense limitation, $78,000 of management fees for
the Virginia Short-Term Bond Fund were not accrued for the year ended
February 28, 1998, and $4,000 of other expenses were borne by T. Rowe Price
and are subject to future reimbursement. Additionally, $102,000 of unaccrued
fees and expenses remain unaccrued from the prior period and are subject to
future reimbursement.
Tax-Efficient Balanced Fund
Pursuant to the present expense limitation, $35,000 of management fees were
not accrued by the Fund for the year ended February 28, 1998. Additionally,
$46,000 of other expenses were borne by the manager.
Tax-Free Intermediate Bond Fund
Management fees were not accrued by the Fund for the year ended February 28,
1998. However, $36,000 of unaccrued fees and expenses from the prior period
are subject to reimbursement pursuant to a previous expense limitation.
DISTRIBUTOR FOR THE FUNDS
-------------------------------------------------------------------------------
T. Rowe Price Investment Services, Inc. ("Investment Services"), a Maryland
corporation formed in 1980 as a wholly owned subsidiary of T. Rowe Price,
serves as Fund's distributor. Investment Services is registered as a
broker-dealer under the Securities Exchange Act of 1934 and is a member of
the National Association of Securities Dealers, Inc. The offering of the
Fund's shares is continuous.
Investment Services is located at the same address as the Fund and T. Rowe
Price-100 East Pratt Street, Baltimore, Maryland 21202.
Investment Services serves as distributor to the Fund pursuant to an
Underwriting Agreement ("Underwriting Agreement"), which provides that the
Fund will pay all fees and expenses in connection with: necessary state
filings; preparing, setting in type, printing, and mailing its prospectuses
and reports to shareholders; and issuing its shares, including expenses of
confirming purchase orders.
The Underwriting Agreement provides that Investment Services will pay all
fees and expenses in connection with: printing and distributing prospectuses
and reports for use in offering and selling Fund shares; preparing, setting
in type, printing, and mailing all sales literature and advertising;
Investment Services' federal and state registrations as a broker-dealer; and
offering and selling shares, except for those fees and expenses specifically
assumed by the Fund. Investment Services' expenses are paid by T. Rowe Price.
Investment Services acts as the agent of the Fund in connection with the sale
of shares in the various states in which Investment Services is qualified as
a broker-dealer. Under the Underwriting Agreement, Investment Services
accepts orders for shares at net asset value. No sales charges are paid by
investors or the Fund.
CUSTODIAN
-------------------------------------------------------------------------------
State Street Bank and Trust Company is the custodian for the Fund's U.S.
securities and cash, but it does not participate in the Fund's investment
decisions. Portfolio securities purchased in the U.S. are maintained in the
custody of the Bank and may be entered into the Federal Reserve Book Entry
System, or the security depository system of the Depository Trust
Corporation. State Street Bank's main office is at 225 Franklin Street,
Boston, Massachusetts 02110.
Tax-Efficient Balanced Fund
The Fund has entered into a Custodian Agreement with The Chase Manhattan
Bank, N.A., London, pursuant to which portfolio securities which are
purchased outside the United States are maintained in the custody of
<PAGE>
various foreign branches of The Chase Manhattan Bank and such other
custodians, including foreign banks and foreign securities depositories as
are approved in accordance with regulations under the Investment Company Act
of 1940. The address for The Chase Manhattan Bank, N.A., London is Woolgate
House, Coleman Street, London, EC2P 2HD, England.
All Funds
SHAREHOLDER SERVICES
-------------------------------------------------------------------------------
T. Rowe Price Services, Inc., another wholly owned subsidiary, acts as the
Fund's transfer and dividend disbursing agent and provides shareholder and
administrative services. Services for certain types of retirement plans are
provided by T. Rowe Price Retirement Plan Services, Inc., also a wholly owned
subsidiary. The address for each is 100 East Pratt St., Baltimore, MD 21202.
The Fund from time to time may enter into agreements with outside parties
through which shareholders hold Fund shares. The shares would be held by such
parties in omnibus accounts. The agreements would provide for payments by the
Fund to the outside party for shareholder services provided to shareholders
in the omnibus accounts.
CODE OF ETHICS
-------------------------------------------------------------------------------
The Fund's investment adviser (T. Rowe Price) has a written Code of Ethics
which requires all employees to obtain prior clearance before engaging in
personal securities transactions. In addition, all employees must report
their personal securities transactions within 10 days of their execution.
Employees will not be permitted to effect transactions in a security: if
there are pending client orders in the security; the security has been
purchased or sold by a client within seven calendar days; the security is
being considered for purchase for a client; the security is subject to
internal trading restrictions. In addition, employees are prohibited from
profiting from short-term trading (e.g., purchases and sales involving the
same security within 60 days). Any material violation of the Code of Ethics
is reported to the Board of the Fund. The Board also reviews the
administration of the Code of Ethics on an annual basis.
PORTFOLIO TRANSACTIONS
-------------------------------------------------------------------------------
Investment or Brokerage Discretion
Decisions with respect to the purchase and sale of portfolio securities on
behalf of the Fund are made by T. Rowe Price. T. Rowe Price is also
responsible for implementing these decisions, including the negotiation of
commissions and the allocation of portfolio brokerage and principal business
(including the equity portion of the Tax-Efficient Balanced Fund).
How Brokers and Dealers Are Selected
Fixed Income Securities
Fixed income securities are generally purchased from the issuer or a primary
market-maker acting as principal for the securities on a net basis, with no
brokerage commission being paid by the client although the price usually
includes an undisclosed compensation. Transactions placed through dealers
serving as primary market-makers reflect the spread between the bid and asked
prices. Securities may also be purchased from underwriters at prices which
include underwriting fees.
With respect to equity and fixed income securities, T. Rowe Price may effect
principal transactions on behalf of the Fund with a broker or dealer who
furnishes brokerage and/or research services, designate any such broker or
dealer to receive selling concessions, discounts or other allowances, or
otherwise deal with any such
<PAGE>
broker or dealer in connection with the acquisition of securities in
underwritings. T. Rowe Price may receive research services in connection with
brokerage transactions, including designations in a fixed price offerings.
How Evaluations Are Made of the Overall Reasonableness of Brokerage Commissions
Paid
On a continuing basis, T. Rowe Price seeks to determine what levels of
commission rates are reasonable in the marketplace for transactions executed
on behalf of the Fund. In evaluating the reasonableness of commission rates,
T. Rowe Price considers: (a) historical commission rates, both before and
since rates have been fully negotiable; (b) rates which other institutional
investors are paying, based on available public information; (c) rates quoted
by brokers and dealers; (d) the size of a particular transaction, in terms of
the number of shares, dollar amount, and number of clients involved; (e) the
complexity of a particular transaction in terms of both execution and
settlement; (f) the level and type of business done with a particular firm
over a period of time; and (g) the extent to which the broker or dealer has
capital at risk in the transaction.
Descriptions of Research Services Received From Brokers and Dealers
T. Rowe Price receives a wide range of research services from brokers and
dealers. These services include information on the economy, industries,
groups of securities, individual companies, statistical information,
accounting and tax law interpretations, political developments, legal
developments affecting portfolio securities, technical market action, pricing
and appraisal services, credit analysis, risk measurement analysis,
performance analysis and analysis of corporate responsibility issues. These
services provide both domestic and international perspective. Research
services are received primarily in the form of written reports, computer
generated services, telephone contacts and personal meetings with security
analysts. In addition, such services may be provided in the form of meetings
arranged with corporate and industry spokespersons, economists, academicians
and government representatives. In some cases, research services are
generated by third parties but are provided to T. Rowe Price by or through
broker-dealers.
Research services received from brokers and dealers are supplemental to T.
Rowe Price's own research effort and, when utilized, are subject to internal
analysis before being incorporated by T. Rowe Price into its investment
process. As a practical matter, it would not be possible for T. Rowe Price's
Equity Research Division to generate all of the information presently
provided by brokers and dealers. T. Rowe Price pays cash for certain research
services received from external sources. T. Rowe Price also allocates
brokerage for research services which are available for cash. While receipt
of research services from brokerage firms has not reduced T. Rowe Price's
normal research activities, the expenses of T. Rowe Price could be materially
increased if it attempted to generate such additional information through its
own staff. To the extent that research services of value are provided by
brokers or dealers, T. Rowe Price may be relieved of expenses which it might
otherwise bear.
T. Rowe Price has a policy of not allocating brokerage business in return for
products or services other than brokerage or research services. In accordance
with the provisions of Section 28(e) of the Securities Exchange Act of 1934,
T. Rowe Price may from time to time receive services and products which serve
both research and non-research functions. In such event, T. Rowe Price makes
a good faith determination of the anticipated research and non-research use
of the product or service and allocates brokerage only with respect to the
research component.
Commissions to Brokers Who Furnish Research Services
Certain brokers and dealers who provide quality brokerage and execution
services also furnish research services to T. Rowe Price. With regard to the
payment of brokerage commissions, T. Rowe Price has adopted a brokerage
allocation policy embodying the concepts of Section 28(e) of the Securities
Exchange Act of 1934, which permits an investment adviser to cause an account
to pay commission rates in excess of those another broker or dealer would
have charged for effecting the same transaction, if the adviser determines in
good faith that the commission paid is reasonable in relation to the value of
the brokerage and research services provided. The determination may be viewed
in terms of either the particular transaction involved or the overall
responsibilities of the adviser with respect to the accounts over which it
exercises investment discretion. Accordingly, while T. Rowe Price cannot
readily determine the extent to which commission rates or net prices charged
by broker-dealers reflect the value of their research services, T. Rowe Price
would expect
<PAGE>
to assess the reasonableness of commissions in light of the total brokerage
and research services provided by each particular broker. T. Rowe Price may
receive research, as defined in Section 28(e), in connection with selling
concessions and designations in fixed price offerings in which the Funds
participate.
Internal Allocation Procedures
T. Rowe Price has a policy of not precommitting a specific amount of business
to any broker or dealer over any specific time period. Historically, the
majority of brokerage placement has been determined by the needs of a
specific transaction such as market-making, availability of a buyer or seller
of a particular security, or specialized execution skills. However, T. Rowe
Price does have an internal brokerage allocation procedure for that portion
of its discretionary client brokerage business where special needs do not
exist, or where the business may be allocated among several brokers or
dealers which are able to meet the needs of the transaction.
Each year, T. Rowe Price assesses the contribution of the brokerage and
research services provided by brokers or dealers, and attempts to allocate a
portion of its brokerage business in response to these assessments. Research
analysts, counselors, various investment committees, and the Trading
Department each seek to evaluate the brokerage and research services they
receive from brokers or dealers and make judgments as to the level of
business which would recognize such services. In addition, brokers or dealers
sometimes suggest a level of business they would like to receive in return
for the various brokerage and research services they provide. Actual
brokerage received by any firm may be less than the suggested allocations but
can, and often does, exceed the suggestions, because the total business is
allocated on the basis of all the considerations described above. In no case
is a broker or dealer excluded from receiving business from T. Rowe Price
because it has not been identified as providing research services.
Miscellaneous
T. Rowe Price's brokerage allocation policy is consistently applied to all
its fully discretionary accounts, which represent a substantial majority of
all assets under management. Research services furnished by brokers or
dealers through which T. Rowe Price effects securities transactions may be
used in servicing all accounts (including non-Fund accounts) managed by T.
Rowe Price. Conversely, research services received from brokers or dealers
which execute transactions for the Fund are not necessarily used by T. Rowe
Price exclusively in connection with the management of the Fund.
From time to time, orders for clients may be placed through a computerized
transaction network.
The Fund does not allocate business to any broker-dealer on the basis of its
sales of the Fund's shares. However, this does not mean that broker-dealers
who purchase Fund shares for their clients will not receive business from the
Fund.
Some of T. Rowe Price's other clients have investment objectives and programs
similar to those of the Fund. T. Rowe Price may occasionally make
recommendations to other clients which result in their purchasing or selling
securities simultaneously with the Fund. As a result, the demand for
securities being purchased or the supply of securities being sold may
increase, and this could have an adverse effect on the price of those
securities. It is T. Rowe Price's policy not to favor one client over another
in making recommendations or in placing orders. T. Rowe Price frequently
follows the practice of grouping orders of various clients for execution
which generally results in lower commission rates being attained. In certain
cases, where the aggregate order is executed in a series of transactions at
various prices on a given day, each participating client's proportionate
share of such order reflects the average price paid or received with respect
to the total order. T. Rowe Price has established a general investment policy
that it will ordinarily not make additional purchases of a common stock of a
company for its clients (including the T. Rowe Price Funds) if, as a result
of such purchases, 10% or more of the outstanding common stock of such
company would be held by its clients in the aggregate.
To the extent possible, T. Rowe Price intends to recapture solicitation fees
paid in connection with tender offers through T. Rowe Price Investment
Services, Inc., the Fund's distributor. At the present time, T. Rowe Price
does not recapture commissions or underwriting discounts or selling group
concessions in connection
<PAGE>
with taxable securities acquired in underwritten offerings. T. Rowe Price
does, however, attempt to negotiate elimination of all or a portion of the
selling-group concession or underwriting discount when purchasing tax-exempt
municipal securities on behalf of its clients in underwritten offerings.
Other
The Funds engaged in portfolio transactions involving broker-dealers in the
following amounts for the fiscal years ended February 28, 1998, 1997, and
February 29, 1996:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 289,794,000 $ 286,416,000 $ 321,786,000
California Tax-Free Money 506,606,000 474,186,000 451,803,000
Florida Intermediate Tax-Free 142,932,000 244,915,000 244,903,000
Georgia Tax-Free Bond 97,029,000 104,491,000 101,969,000
Maryland Tax-Free Bond 918,045,000 775,356,000 608,562,000
Maryland Short-Term Tax-Free
Bond 221,540,000 112,384,000 181,246,000
New Jersey Tax-Free Bond 161,209,000 238,572,000 244,765,000
New York Tax-Free Bond 354,373,000 432,992,000 479,720,000
New York Tax-Free Money 444,785,000 451,170,000 323,642,000
Virginia Tax-Free Bond 563,466,000 508,640,000 586,982,000
Virginia Short-Term Tax-Free
Bond 56,461,000 35,817,000 33,183,000
Tax-Efficient Balanced 39,110,000 (a) (a)
Tax-Exempt Money 3,600,294,000 3,675,043,000 3,101,344,000
Tax-Free High Yield 1,755,491,000 1,801,447,000 1,643,296,000
Tax-Free Income 2,257,818,000 2,284,715,000 2,558,129,000
Tax-Free Intermediate Bond 272,682,000 320,231,000 249,376,000
Tax-Free Short-Intermediate 1,149,079,000 1,478,084,000 1,184,341,000
- -------------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
The following amounts consisted of principal transactions as to which the
Funds have no knowledge of the profits or losses realized by the respective
broker-dealers for the fiscal years ended February 28, 1998, 1997, and
February 29, 1996:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 253,929,000 $ 260,704,000 $ 298,191,000
California Tax-Free Money 503,591,000 472,277,000 449,790,000
Florida Intermediate Tax-Free 128,653,000 229,787,000 234,913,000
Georgia Tax-Free Bond 85,009,000 98,598,000 95,309,000
Maryland Tax-Free Bond 793,036,000 680,479,000 530,615,000
Maryland Short-Term Tax-Free
Bond 193,471,000 108,581,000 178,280,000
New Jersey Tax-Free Bond 136,223,000 225,435,000 232,059,000
New York Tax-Free Bond 299,419,000 394,711,000 465,446,000
New York Tax-Free Money 441,384,000 451,170,000 323,642,000
Virginia Tax-Free Bond 518,159,000 483,074,000 550,422,000
Virginia Short-Term Tax-Free
Bond 55,291,000 34,013,000 32,888,000
Tax-Efficient Balanced 27,555,000 (a) (a)
Tax-Exempt Money 3,586,230,000 3,662,460,000 3,084,964,000
Tax-Free High Yield 1,527,098,000 1,621,470,000 1,501,879,000
Tax-Free Income 1,959,351,000 2,034,461,000 2,318,802,000
Tax-Free Intermediate Bond 249,144,000 302,633,000 233,485,000
Tax-Free Short-Intermediate 1,083,550,000 1,384,758,000 1,113,118,000
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Prior to commencement of operations.
The following amounts involved trades with brokers acting as agents or
underwriters for the fiscal years ended February 28, 1998, 1997, and February
29, 1996:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 35,865,000 $ 25,712,000 $ 23,595,000
California Tax-Free Money 3,016,000 1,909,000 2,013,000
Florida Intermediate Tax-Free 14,279,000 15,128,000 9,990,000
Georgia Tax-Free Bond 12,020,000 5,893,000 6,660,000
Maryland Tax-Free Bond 125,009,000 94,877,000 77,947,000
Maryland Short-Term Tax-Free Bond 28,069,000 3,803,000 2,966,000
New Jersey Tax-Free Bond 24,987,000 13,137,000 12,706,000
New York Tax-Free Bond 54,954,000 38,281,000 14,274,000
New York Tax-Free Money 3,401,000 0 0
Virginia Tax-Free Bond 45,307,000 25,566,000 36,560,000
Virginia Short-Term Tax-Free Bond 1,170,000 1,804,000 295,000
Tax-Efficient Balanced 11,555,000 (a) (a)
Tax-Exempt Money 14,064,000 12,583,000 16,380,000
Tax-Free High Yield 228,393,000 179,977,000 141,417,000
Tax-Free Income 298,468,000 250,254,000 239,327,000
Tax-Free Intermediate Bond 23,538,000 17,598,000 15,891,000
Tax-Free Short-Intermediate 65,529,000 93,326,000 71,223,000
- -----------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
The following amounts involved trades with brokers acting as agents or
underwriters, in which such brokers received total commissions, including
discounts received in connection with underwritings for the fiscal years
ended February 28, 1998, 1997, and February 29, 1996:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond $ 206,000 $ 111,000 $ 152,000
California Tax-Free Money 2,000 1,000 6,000
Florida Intermediate Tax-Free 59,000 85,000 42,000
Georgia Tax-Free Bond 74,000 30,000 30,000
Maryland Tax-Free Bond 680,000 371,000 243,000
Maryland Short-Term Tax-Free Bond 106,000 12,000 10,000
New Jersey Tax-Free Bond 176,000 75,000 62,000
New York Tax-Free Bond 362,000 251,000 92,000
New York Tax-Free Money 24,000 0 0
Virginia Tax-Free Bond 271,000 121,000 188,000
Virginia Short-Term Tax-Free Bond 6,000 4,000 1,000
Tax-Efficient Balanced 33,000 (a) (a)
Tax-Exempt Money 32,000 13,000 70,000
Tax-Free High Yield 1,655,000 1,139,000 970,000
Tax-Free Income 1,747,000 1,493,000 1,608,000
Tax-Free Intermediate Bond 112,000 108,000 61,000
Tax-Free Short-Intermediate 289,000 370,000 281,000
- --------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
(a) Prior to commencement of operations.
Of all such portfolio transactions, none were placed with firms which
provided research, statistical, or other services to T. Rowe Price in
connection with the management of the Funds, or in some cases, to the Funds.
The portfolio turnover rate for each Fund for the fiscal years ended February
28, 1998, 1997, and February 29, 1996, was as follows:
<TABLE>
<CAPTION>
Fund 1998 1997 1996
---- ---- ---- ----
<S> <C> <C> <C>
California Tax-Free Bond 35.0% 47.3% 61.9%
California Tax-Free Money N/A N/A N/A
Florida Intermediate Tax-Free 25.0 75.8 98.7
Georgia Tax-Free Bond 49.0 71.1 71.5
Maryland Tax-Free Bond 19.2 26.2 23.9
Maryland Short-Term Tax-Free Bond 60.4 21.4 39.3
New Jersey Tax-Free Bond 34.3 78.9 98.4
New York Tax-Free Bond 55.0 96.9 116.0
New York Tax-Free Money N/A N/A N/A
Virginia Tax-Free Bond 64.3 66.2 93.7
Virginia Short-Term Tax-Free Bond 75.0 32.5 36.4
Tax-Efficient Balanced 12.5 (a) (a)
Tax-Exempt Money N/A N/A N/A
Tax-Free High Yield 24.4 37.0 39.3
Tax-Free Income 36.3 40.7 48.7
Tax-Free Intermediate Bond 56.1 76.8 63.8
Tax-Free Short-Intermediate 76.8 84.3 69.9
- ---------------------------------------------------------------------------------------------
</TABLE>
(a) Prior to commencement of operations.
PRICING OF SECURITIES
-------------------------------------------------------------------------------
Fixed income securities are generally traded in the over-the-counter market.
With the exception of the Money Funds, investments in securities are stated
at fair value using a bid-side valuation as furnished by dealers who make
markets in such securities or by an independent pricing service, which
considers yield or price of bonds of comparable quality, coupon, maturity,
and type, as well as prices quoted by dealers who make markets in such
securities. Securities held by the Money Funds are valued at amortized cost.
There are a number of pricing services available, and the Board of
Directors/Trustees, on the basis of an ongoing evaluation of these services,
may use or may discontinue the use of any pricing service in whole or part.
<PAGE>
Securities or other assets for which the above valuation procedures are
deemed not to reflect fair value will be appraised at prices deemed best to
reflect their fair value. Such determinations will be made in good faith by
or under the supervision of officers of each Fund as authorized by the Board
of Directors/Trustees.
Tax-Efficient Balanced Fund
The Fund's municipal securities will be priced as described above. Equity
securities listed or regularly traded on a securities exchange are valued at
the last quoted sales price at the time the valuations are made. A security
that is listed or traded on more than one exchange is valued at the quotation
on the exchange determined to be the primary market for such security. Listed
securities not traded on a particular day and securities regularly traded in
the over-the-counter market are valued at the mean of the latest bid and
asked prices. Other equity securities are valued at a price within the limits
of the latest bid and asked prices deemed by the Board of Directors/Trustees,
or by persons delegated by the Board, best to reflect fair value.
Investments in mutual funds are valued at the closing net asset value per
share of the mutual fund on the day of valuation. In the absence of a last
sale price, purchased and written options are valued at the mean of the
latest bid and asked prices, respectively.
For the purposes of determining the Fund's net asset value per share, the
U.S. dollar value of all assets and liabilities initially expressed in
foreign currencies is determined by using the mean of the bid and offer
prices of such currencies against U.S. dollars quoted by a major bank.
Assets and liabilities for which the above valuation procedures are
inappropriate or are deemed not to reflect fair value, are stated at fair
value as determined in good faith by or under the supervision of the officers
of the Fund, as authorized by the Board of Directors/Trustees.
Maintenance of Money Fund's Net Asset Value Per Share at $1.00
It is the policy of the Fund to attempt to maintain a net asset value of
$1.00 per share by using the amortized cost method of valuation permitted by
Rule 2a-7 under the Investment Company Act of 1940. Under this method,
securities are valued by reference to the Fund's acquisition cost as adjusted
for amortization of premium or accumulation of discount rather than by
reference to their market value. Under Rule 2a-7:
(a) The Board of Directors/Trustees must establish written procedures
reasonably designed, taking into account current market conditions and
the Fund's investment objectives, to stabilize the Fund's net asset value
per share, as computed for the purpose of distribution, redemption and
repurchase, at a single value;
(b) The Fund must (i) maintain a dollar-weighted average portfolio maturity
appropriate to its objective of maintaining a stable price per share,
(ii) not purchase any instrument with a remaining maturity greater than
397 days, and (iii) maintain a dollar-weighted average portfolio maturity
of 90 days or less;
(c) The Fund must limit its purchase of portfolio instruments, including
repurchase agreements, to those U.S. dollar-denominated instruments which
the Fund's Board of Directors/Trustees determines present minimal credit
risks, and which are eligible securities as defined by Rule 2a-7; and
(d) The Board of Directors/Trustees must determine that (i) it is in the best
interest of the Fund and its shareholders to maintain a stable net asset
value per share under the amortized cost method; and (ii) the Fund will
continue to use the amortized cost method only so long as the Board of
Directors/ Trustees believes that it fairly reflects the market based net
asset value per share.
Although the Fund believes that it will be able to maintain its net asset
value at $1.00 per share under most conditions, there can be no absolute
assurance that it will be able to do so on a continuous basis. If the Fund's
net asset value per share declined, or was expected to decline, below $1.00
(rounded to the nearest one cent), the Board of Directors/Trustees of the
Fund might temporarily reduce or suspend dividend payments in an effort to
maintain the net asset value at $1.00 per share. As a result of such
reduction or suspension of dividends, an investor would receive less income
during a given period than if such a reduction or suspension
<PAGE>
had not taken place. Such action could result in an investor receiving no
dividend for the period during which he holds his shares and in his
receiving, upon redemption, a price per share lower than that which he paid.
On the other hand, if the Fund's net asset value per share were to increase,
or were anticipated to increase above $1.00 (rounded to the nearest one
cent), the Board of Directors/Trustees of the Fund might supplement dividends
in an effort to maintain the net asset value at $1.00 per share.
NET ASSET VALUE PER SHARE
-------------------------------------------------------------------------------
The purchase and redemption price of the Fund's shares is equal to the Fund's
net asset value per share or share price. The Fund determines its net asset
value per share by subtracting its liabilities (including accrued expenses
and dividends payable) from its total assets (the market value of the
securities the Fund holds plus cash and other assets, including income
accrued but not yet received) and dividing the result by the total number of
shares outstanding. The net asset value per share of the Fund is normally
calculated as of the close of trading on the New York Stock Exchange ("NYSE")
every day the NYSE is open for trading. The NYSE is closed on the following
days: New Year's Day, Dr. Martin Luther King, Jr. Holiday, Presidents' Day,
Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and
Christmas Day.
Determination of net asset value (and the offering, sale redemption and
repurchase of shares) for the Fund may be suspended at times (a) during which
the NYSE is closed, other than customary weekend and holiday closings, (b)
during which trading on the NYSE is restricted, (c) during which an emergency
exists as a result of which disposal by the Fund of securities owned by it is
not reasonably practicable or it is not reasonably practicable for the Fund
fairly to determine the value of its net assets, or (d) during which a
governmental body having jurisdiction over the Fund may by order permit such
a suspension for the protection of the Fund's shareholders; provided that
applicable rules and regulations of the Securities and Exchange Commission
(or any succeeding governmental authority) shall govern as to whether the
conditions prescribed in (b), (c), or (d) exist.
DIVIDENDS AND DISTRIBUTIONS
-------------------------------------------------------------------------------
Unless you elect otherwise, the Fund's annual capital gain distribution and,
for the Tax-Efficient Balanced Fund, the annual dividend, if any, will be
reinvested on the reinvestment date using the NAV per share of that date. The
reinvestment date may precede the payment date by as much as 10 days although
the exact timing is subject to change.
TAX STATUS
-------------------------------------------------------------------------------
The Fund intends to qualify as a "regulated investment company" under
Subchapter M of the Code.
Dividends paid by certain Funds may be eligible for the dividends-received
deduction applicable to corporate shareholders. For tax purposes, it does not
make any difference whether dividends and capital gain distributions are paid
in cash or in additional shares. The Fund must declare dividends by December
31 of each year equal to at least 98% of ordinary income (as of December 31)
and capital gains (as of October 31) in order to avoid a federal excise tax
and distribute within 12 months 100% of ordinary income and capital gains as
of December 31 to avoid a federal income tax.
At the time of your purchase, the Fund's net asset value may reflect
undistributed capital gains or net unrealized appreciation of securities held
by the Fund. A subsequent distribution to you of such amounts, although
constituting a return of your investment, would be taxable as a capital gain
distribution. For federal income tax purposes, the Fund is permitted to carry
forward its net realized capital losses, if any, for eight
<PAGE>
years and realize net capital gains up to the amount of such losses without
being required to pay taxes on, or distribute, such gains.
If, in any taxable year, the Fund should not qualify as a regulated
investment company under the code: (i) the Fund would be taxed at normal
corporate rates on the entire amount of its taxable income, if any, without
deduction for dividends or other distributions to shareholders; and (ii) the
Fund's distributions to the extent made out of the Fund's current or
accumulated earnings and profits would be taxable to shareholders as ordinary
dividends (regardless of whether they would otherwise have been considered
capital gain dividends).
The Funds anticipate acquiring bonds after initial issuance at a price less
than the principal amount of such bonds ("market discount bonds"). Gain on
the disposition of such bonds is treated as taxable ordinary income to the
extent of accrued market discount. Such gains cannot be offset by losses on
the sale of other securities but must be distributed to shareholders annually
and taxed as ordinary income.
Each year, the Funds will mail you information on the tax status of dividends
and distributions. The Funds anticipate that substantially all of the
dividends to be paid by each Fund will be exempt from federal income taxes.
If any portion of a Fund's dividends is not exempt from federal income taxes,
you will receive a Form 1099 stating the taxable portion. The Funds will also
advise you of the percentage of your dividends, if any, which should be
included in the computation of alternative minimum tax. Social security
recipients who receive interest from tax-exempt securities may have to pay
taxes on a portion of their social security benefit.
Because the interest on municipal securities is tax exempt, any interest on
money you borrow that is directly or indirectly used to purchase Fund shares
is not deductible. (See Section 265(2) of the Internal Revenue Code.)
Further, entities or persons who are "substantial users" (or persons related
to "substantial users") of facilities financed by industrial development
bonds should consult their tax advisers before purchasing shares of a Fund.
The income from such bonds may not be tax exempt for such substantial users.
Florida Intermediate Tax-Free Fund
Although Florida does not have a state income tax, it does impose an
intangible personal property tax (intangibles tax) on assets, including
shares of mutual funds. This tax is based on the net asset value of shares
owned on January 1.
Under Florida law, shares of the Fund will be exempt from the intangibles tax
to the extent that, on January 1, the Fund's assets are solely invested in
certain exempt Florida securities, U.S. government securities, certain
short-term cash investments, or other exempt securities. If, on January 1,
the Fund's assets are invested in these tax-exempt securities and other
non-tax-exempt securities, only that portion of a share's net asset value
represented by U.S. government securities will be exempt from the intangibles
tax. Because the Fund will make every effort to have its portfolio invested
exclusively in exempt Florida municipal obligations (and other qualifying
investments) on January 1, shares of the Fund should be exempt from the
intangibles tax. However, under certain circumstances, the Fund may invest in
securities other than Florida municipal obligations and there can be no
guarantee that such non-exempt investments would not be in the Fund's
portfolio on January 1. In such cases, all or a portion of the value of the
Fund's shares may be subject to the intangibles tax, and a portion of the
Fund's income may be subject to federal income taxes.
YIELD INFORMATION
-------------------------------------------------------------------------------
Money Funds
The Fund's current and historical yield for a period is calculated by
dividing the net change in value of an account (including all dividends
accrued and dividends reinvested in additional shares) by the account value
at the beginning of the period to obtain the base period return. This base
period return is divided by the number of days in the period than multiplied
by 365 to arrive at the annualized yield for that period. The Fund's
annualized compound yield for such period is compounded by dividing the base
period return by the number of days in the period, and compounding that
figure over 365 days.
<PAGE>
The Money Funds' current and compound yields for the seven days ended
February 28, 1998, were:
<TABLE>
<CAPTION>
Fund Current Yield Compound Yield
---- ------------- --------------
<S> <C> <C>
California Tax-Free Money 2.71% 2.75%
New York Tax-Free Money 2.90 2.94
Tax-Exempt Money 2.99 3.03
</TABLE>
Bond Funds
An income factor is calculated for each security in the portfolio based upon
the security's market value at the beginning of the period and yield as
determined in conformity with regulations of the SEC. The income factors are
then totaled for all securities in the portfolio. Next, expenses of the Fund
for the period, net of expected reimbursements, are deducted from the income
to arrive at net income, which is then converted to a per share amount by
dividing net income by the average number of shares outstanding during the
period. The net income per share is divided by the net asset value on the
last day of the period to produce a monthly yield which is then annualized.
If applicable, a taxable-equivalent yield is calculated by dividing this
yield by one minus the effective federal, state, and/or city or local income
tax rates. Quoted yield factors are for comparison purposes only, and are not
intended to indicate future performance or forecast the dividend per share of
the Fund.
The yield of each Fund calculated under the above-described method for the
month ended February 28, 1998, was:
<TABLE>
<CAPTION>
<S> <C>
California Tax-Free Bond Fund 4.12%
Florida Intermediate Tax-Free Fund 3.63
Georgia Tax-Free Bond Fund 4.04
Maryland Tax-Free Bond Fund 4.20
Maryland Short-Term Tax-Free Bond Fund 3.28
New Jersey Tax-Free Bond Fund 4.26
New York Tax-Free Bond Fund 4.24
Virginia Tax-Free Bond Fund 4.29
Virginia Short-Term Tax-Free Bond Fund 3.30
Tax-Efficient Balanced Fund N/A
Tax-Free High Yield Fund 4.54
Tax-Free Income Fund 4.28
Tax-Free Intermediate Bond Fund 3.69
Tax-Free Short-Intermediate Fund 3.54
</TABLE>
The tax equivalent yields (assuming a federal tax bracket of 31.0%) for each
Fund for the same period were as follows:
<TABLE>
<CAPTION>
<S> <C>
California Tax-Free Bond Fund(a) 6.58%
Florida Intermediate Tax-Free Fund(b) 5.46
Georgia Tax-Free Bond Fund(c) 6.22
Maryland Tax-Free Bond Fund(d) 6.61
Maryland Short-Term Tax-Free Bond Fund(d) 5.17
New Jersey Tax-Free Bond Fund(e) 6.59
New York Tax-Free Bond Fund(f) 6.85
Virginia Tax-Free Bond Fund(g) 6.60
Virginia Short-Term Tax-Free Bond Fund(g) 5.08
Tax-Efficient Balanced Fund N/A
Tax-Free High Yield Fund 6.58
Tax-Free Income Fund 6.20
Tax-Free Intermediate Bond Fund 5.35
Tax-Free Short-Intermediate Fund 5.13
- ----------------------------------------------------------------
</TABLE>
<PAGE>
(a) Assumes a state tax bracket of 9.3%.
(b) Assumes an intangible tax rate of 0.2%.
(c) Assumes a state tax bracket of 6.0%.
(d) Assumes a state tax bracket of 4.95% and a local tax bracket
of 2.97%.
(e) Assumes a state tax bracket of 6.37%.
(f) Assumes a state tax bracket of 6.85% and a local tax bracket
of 3.4%.
(g) Assumes a state tax bracket of 5.75%.
The tax equivalent yields (assuming a federal tax bracket of 28.0%) for each
Fund for the same period were as follows:
<TABLE>
<CAPTION>
<S> <C>
California Tax-Free Bond Fund(a) 6.31%
Florida Intermediate Tax-Free Fund(b) 5.24
Georgia Tax-Free Bond Fund(c) 5.97
Maryland Tax-Free Bond Fund(d) 6.33
Maryland Short-Term Tax-Free Bond Fund(d) 4.95
New Jersey Tax-Free Bond Fund(e) 6.26
New York Tax-Free Bond Fund(f) 6.56
Virginia Tax-Free Bond Fund(g) 6.32
Virginia Short-Term Tax-Free Bond Fund(g) 4.86
Tax-Efficient Balanced Fund N/A
Tax-Free High Yield Fund 6.31
Tax-Free Income Fund 5.94
Tax-Free Intermediate Bond Fund 5.13
Tax-Free Short-Intermediate Fund 4.92
- ----------------------------------------------------------------
</TABLE>
(a) Assumes a state tax bracket of 9.3%.
(b) Assumes an intangible tax rate of 0.2%.
(c) Assumes a state tax bracket of 6.0%.
(d) Assumes a state tax bracket of 4.95% and a local tax bracket
of 2.97%.
(e) Assumes a state tax bracket of 5.525%.
(f) Assumes a state tax bracket of 6.85% and a local tax bracket
of 3.4%.
(g) Assumes a state tax bracket of 5.75%.
<PAGE>
TAX-EXEMPT VS. TAXABLE YIELDS
-------------------------------------------------------------------------------
From time to time, a Fund may also illustrate the effect of tax-equivalent
yields using information such as that set forth below:
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) A Tax-Exempt Yield Of:(c)
2% 3% 4% 5% 6%
Federal Tax Is Equivalent to a
Joint Return Single Return Rates(b) Taxable Yield of:
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
$42,351-$102,300 $25,351-$61,400 28.0% 2.78 4.17 5.56 6.94 8.33
102,301-155,950 61,401-128,100 31.0 2.90 4.35 5.80 7.25 8.70
155,951-278,450 128,101-278,450 36.0 3.13 4.69 6.25 7.81 9.38
278,451 and above 278,451 and above 39.6 3.31 4.97 6.62 8.28 9.93
- -----------------------------------------------------------------------------------------------
Your Taxable Income(1998)(a) A Tax-Exempt Yield Of:(c)
7% 8% 9% 10%
Joint Return Single Return Federal Tax Is Equivalent to a
Rates(b) Taxable Yield of:
- -----------------------------------------------------------------------------------------------
$42,351-$102,300 $25,351-$61,400 28.0% 9.72 11.11 12.50 13.89
102,301-155,950 61,401-128,100 31.0 10.14 11.59 13.04 14.49
155,951-278,450 128,101-278,450 36.0 10.94 12.50 14.06 15.63
278,451 and above 278,451 and above 39.6 11.59 13.25 14.90 16.56
- -----------------------------------------------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size and nature and amount of
itemized deductions.
(c) Combined marginal rate assumes the deduction of state income taxes on the
federal return.
California Funds
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Combined Marginal(c)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$37,522-$42,350 $18,761-$25,350 15.0 6.0 20.1
42,351-52,090 25,351-26,045 28.0 6.0 32.3
52,091-65,832 26,046-32,916 28.0 8.0 33.8
65,833-102,300 32,917-61,400 28.0 9.3 34.7
102,301-155,950 61,401-128,100 31.0 9.3 37.4
155,951-278,450 128,101-278,450 36.0 9.3 42.0
278,451 and above 278,451 and above 39.6 9.3 45.2
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- -------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
3.75 5.01 6.26 7.51 8.76 10.01 '11.26 12.52
4.43 5.91 7.39 8.86 10.34 11.82 13.29 14.77
4.53 6.04 7.55 9.06 10.57 12.08 13.60 15.11
4.59 6.13 7.66 9.19 10.72 12.25 13.78 15.31
4.79 6.39 7.99 9.58 11.18 12.78 14.38 15.97
5.17 6.90 8.62 10.34 12.07 13.79 15.52 17.24
5.47 7.30 9.12 10.95 12.77 14.60 16.42 18.25
- -------------------------------------------------------
</TABLE>
<PAGE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
Georgia Tax-Free Bond Fund
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Combined Marginal(c)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$42,351-$102,300 $25,351-$61,400 28.0 6.00 32.3
102,301-155,950 61,401-128,100 31.0 6.00 35.1
155,951-278,450 128,101-278,450 36.0 6.00 39.8
278,451 and above 278,451 and above 39.6 6.00 43.2
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
4.43 5.91 7.39 8.86 10.34 11.82 13.29 14.77
4.62 6.16 7.70 9.24 10.79 12.33 13.87 15.41
4.98 6.64 8.31 9.97 11.63 13.29 14.95 16.61
5.28 7.04 8.80 10.56 12.32 14.08 15.85 17.61
- ------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
Maryland Funds
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Local(c) Combined Marginal(d)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$42,351-$102,300 $25,351-$61,400 28.0 4.95 2.97 33.7
102,301-155,950 61,401-128,100 31.0 4.95 2.97 36.5
155,951-278,450 128,101-278,450 36.0 4.95 2.97 41.1
278,451 and above 278,451 and above 39.6 4.95 2.97 44.4
- -----------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
4.52 6.03 7.54 9.05 10.56 12.07 13.57 15.08
4.72 6.30 7.87 9.45 11.02 12.60 14.17 15.75
5.09 6.79 8.49 10.19 11.88 13.58 15.28 16.98
5.40 7.19 8.99 10.79 12.59 14.39 16.19 17.99
- ------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Assumes a local tax rate equal to 60% of the state rate for residents
in the 5% state bracket.
(d) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
New Jersey Tax-Free Bond Fund
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Combined Marginal(c)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$0-$20,000 $0-$20,000 15.0 1.400 16.2
20,001-42,350 20,001-25,350 15.0 1.750 16.5
42,351-50,000 25,351-35,000 28.0 1.750 29.3
50,001-70,000 -- 28.0 2.450 29.8
70,001-80,000 35,001-40,000 28.0 3.500 30.5
80,001-102,300 40,001-61,400 28.0 5.525 32.0
102,301-150,000 61,401-75,000 31.0 5.525 34.8
150,001-155,950 75,001-128,100 31.0 6.370 35.4
155,951-278,450 128,101-278,450 36.0 6.370 40.1
278,451 and above 278,451 and above 39.6 6.370 43.4
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
3.58 4.77 5.97 7.16 8.35 9.55 10.74 11.93
3.59 4.79 5.99 7.19 8.38 9.58 10.78 11.98
4.24 5.66 7.07 8.49 9.90 11.32 12.73 14.14
4.27 5.70 7.12 8.55 9.97 11.40 12.82 14.25
4.32 5.76 7.19 8.63 10.07 11.51 12.95 14.39
4.41 5.88 7.35 8.82 10.29 11.76 13.24 14.71
4.60 6.13 7.67 9.20 10.74 12.27 13.80 15.34
4.64 6.19 7.74 9.29 10.84 12.38 13.93 15.48
5.01 6.68 8.35 10.02 11.69 13.36 15.03 16.69
5.30 7.07 8.83 10.60 12.37 14.13 15.90 17.67
- ------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
<PAGE>
New York Funds
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Local(c) Combined Marginal(d)
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$26,000-$40,000 $13,000-$20,000 15.0 5.90 3.30 22.8
40,001-42,350 20,001-25,000 15.0 6.85 3.30 23.6
-- 25,001-25,350 15.0 6.85 3.35 23.7
42,351-45,000 -- 28.0 6.85 3.30 35.3
45,001-90,000 25,351-50,000 28.0 6.85 3.35 35.3
90,001-102,300 50,001-61,400 28.0 6.85 3.40 35.4
102,301-155,950 61,401-128,100 31.0 6.85 3.40 38.1
155,951-278,450 128,101-278,450 36 6.85 3.40 42.6
278,451 and above 278,451 and above 39.6 6.85 3.40 45.8
- -----------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
3.89 5.18 6.48 7.77 9.07 10.36 11.66 12.95
3.93 5.24 6.54 7.85 9.16 10.47 11.78 13.09
3.93 5.24 6.55 7.86 9.17 10.48 11.80 13.11
4.64 6.18 7.73 9.27 10.82 12.36 13.91 15.46
4.64 6.18 7.73 9.27 10.82 12.36 13.91 15.46
4.64 6.19 7.74 9.29 10.84 12.38 13.93 15.48
4.85 6.46 8.08 9.69 11.31 12.92 14.54 16.16
5.23 6.97 8.71 10.45 12.20 13.94 15.68 17.42
5.54 7.38 9.23 11.07 12.92 14.76 16.61 18.45
- ------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Tax rates are for New York City residents.
(d) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
Virginia Funds
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a) Marginal Tax Rates
Joint Return Single Return Federal(b) State Combined Marginal(c)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$42,351-$102,300 $25,351-$61,400 28.0 5.75 32.1
102,301-155,950 61,401-128,100 31.0 5.75 35.0
155,951-278,450 128,101-278,450 36.0 5.75 39.7
278,451 and above 278,451 and above 39.6 5.75 43.1
- -------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of:
3% 4% 5% 6% 7% 8% 9% 10%
Is Equivalent to a Taxable Yield of:
- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
4.42 5.89 7.36 8.84 10.31 11.78 13.25 14.73
4.62 6.15 7.69 9.23 10.77 12.31 13.85 15.38
4.98 6.63 8.29 9.95 11.61 13.27 14.93 16.58
5.27 7.03 8.79 10.54 12.30 14.06 15.82 17.57
- ------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Marginal rates may vary depending on family size, nature and amount
of itemized deductions.
(c) Combined marginal rate assumes the deduction of state income taxes on
the federal return.
Florida Intermediate Tax-Free Fund
EFFECTIVE YIELD FACTORING IN INTANGIBLES TAX
<TABLE>
<CAPTION>
Your Taxable Income(1998)(a)
Federal Tax Intangible Tax
Joint Return Single Return Rates(b) Rate
- -----------------------------------------------------------------------------
<S> <S> <C> <C>
$42,351-$102,300 $25,350-$61,400
And Your Intangible Assets on 1/1/97 Total:
40,000 or less 20,000 or less$ 28 N/A
40,001-200,000 20,001-100,000 28 0.1
200,001 and above 100,001 and above 28 0.2
- -----------------------------------------------------------------------------
$102,301-$155,950 $61,401-$128,100
And Your Intangible Assets on 1/1/97 Total:
40,000 or less 20,000 or less$ 31 N/A
40,001-200,000 20,001-100,000 31 0.1
200,001 and above 100,001 and above 31 0.2
- -----------------------------------------------------------------------------
$155,951-$278,450 $128,101-$278,450
And Your Intangible Assets on 1/1/97 Total:
40,000 or less 20,000 or less$ 36 N/A
40,001-200,000 20,001-100,000 36 0.1
200,001 and above 100,001 and above 36 0.2
- -----------------------------------------------------------------------------
$278,451 and above+ $278,451 and above+
- -----------------------------------------------------------------------------
And Your Intangible Assets on 1/1/97 Total:
40,000 or less 20,000 or less$ 39.6 N/A
40,001-200,000 20,001-100,000 39.6 0.1
200,001 and above 100,001 and above 39.6 0.2
- -----------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
A Tax-Exempt Yield of(c):
3% 4% 5% 6% 7% 8% 9% 10% 11%
Is Equivalent to a Taxable Yield of:
- -------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
4.17 5.56 6.94 8.33 9.72 11.11 12.50 13.89 15.28
4.27 5.66 7.04 8.43 9.82 11.21 12.60 13.99 15.38
4.37 5.76 7.14 8.53 9.92 11.31 12.70 14.09 15.48
- -------------------------------------------------------------
4.35 5.80 7.25 8.70 10.14 11.59 13.04 14.49 15.94
4.45 5.90 7.35 8.80 10.24 11.69 13.14 14.59 16.04
4.55 6.00 7.45 8.90 10.34 11.79 13.24 14.69 16.14
- -------------------------------------------------------------
4.69 6.25 7.81 9.38 10.94 12.50 14.06 15.63 17.19
4.79 6.35 7.91 9.48 11.04 12.60 14.16 15.73 17.29
4.89 6.45 8.01 9.58 11.14 12.70 14.26 15.83 17.39
- -------------------------------------------------------------
4.97 6.62 8.28 9.93 11.59 13.25 14.90 16.56 18.21
5.07 6.72 8.38 10.03 11.69 13.35 15.00 16.66 18.31
5.17 6.82 8.48 10.13 11.79 13.45 15.10 16.76 18.41
- -------------------------------------------------------------
</TABLE>
(a) Net amount subject to federal income tax after deductions and
exemptions.
(b) Federal rates may vary depending on family size, nature and amount of
itemized deductions.
(c) Assumes 100% exemption from federal income and Florida intangible
property taxes.
INVESTMENT PERFORMANCE
-------------------------------------------------------------------------------
Total Return Performance
The Fund's calculation of total return performance includes the reinvestment
of all capital gain distributions and income dividends for the period or
periods indicated, without regard to tax consequences to a shareholder in the
Fund. Total return is calculated as the percentage change between the
beginning value of a static account in the Fund and the ending value of that
account measured by the then current net asset value, including all shares
acquired through reinvestment of income and capital gain dividends. The
results shown are historical and should not be considered indicative of the
future performance of the Fund. Each average annual compound rate of return
is derived from the cumulative performance of the Fund over the time period
specified. The annual compound rate of return for the Fund over any other
period of time will vary from the average.
<PAGE>
<TABLE>
<CAPTION>
Cumulative Performance Percentage Change
Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception
---- ----------- ------------ ------------- -------------- ---------
- ------------------------ 2/28/98 2/28/98 2/28/98 tion 2/28/98 Date
------- ------- ------- ------------ ----
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
California Tax-Free
Bond 9.31% 36.32% 108.49% 115.36% 09/15/86
Florida Intermediate
Tax-Free 6.71 -- -- 33.38 03/31/93
Georgia Tax-Free Bond 9.70 -- -- 40.34 03/31/93
Maryland Short-Term
Tax-Free Bond 4.56 22.12 -- 24.16 01/29/93
Maryland Tax-Free Bond 8.68 35.04 107.48 106.24 03/31/87
New Jersey Tax-Free
Bond 9.24 34.45 -- 69.16 04/30/91
New York Tax-Free Bond 9.75 36.33 113.15 126.95 08/28/86
Virginia Short-Term
Tax-Free Bond 4.48 -- -- 17.52 11/30/94
Virginia Tax-Free Bond 9.03 36.33 -- 68.20 04/30/91
Tax-Efficient Balanced -- -- 14.96 06/30/97
Tax-Free High Yield 10.42 41.23 127.76 228.24 03/01/85
Tax-Free Income 9.37 35.94 109.98 350.74 10/26/76
Tax-Free Intermediate
Bond 7.31 32.65 -- 41.68 11/30/92
Tax-Free 5.28 24.64 69.87 125.08 12/23/83
Short-Intermediate
- ---------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Average Annual Compound Rates of Return
Fund 1 Yr. Ended 5 Yrs. Ended 10 Yrs. Ended % Since Incep- Inception
---- ----------- ------------ ------------- -------------- ---------
- ------------------------ 2/28/98 2/28/98 2/28/98 tion 2/28/98 Date
------- ------- ------- ------------ ----
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
California Tax-Free
Bond 9.31% 6.39% 7.62% 6.93% 09/15/86
Florida Intermediate
Tax-Free 6.71 -- -- 6.04 03/31/93
Georgia Tax-Free Bond 9.70 -- -- 7.14 03/31/93
Maryland Short-Term
Tax-Free Bond 4.56 4.08 -- 4.35 01/29/93
Maryland Tax-Free Bond 8.68 6.19 7.57 6.86 03/31/87
New Jersey Tax-Free
Bond 9.24 6.10 -- 8.00 04/30/91
New York Tax-Free Bond 9.75 6.39 7.86 7.38 08/28/86
Virginia Short-Term
Tax-Free Bond 4.48 -- -- 5.10 11/30/94
Virginia Tax-Free Bond 9.03 6.39 -- 7.91 04/30/91
Tax-Efficient Balanced -- -- -- 06/30/97
Tax-Free High Yield 10.42 7.15 8.58 9.58 03/01/85
Tax-Free Income 9.37 6.33 7.70 7.31 10/26/76
Tax-Free Intermediate
Bond 7.31 5.81 -- 6.87 11/30/92
Tax-Free 5.28 4.50 5.44 5.89 12/23/83
Short-Intermediate
- ---------------------------------------------------------------------------------------------
</TABLE>
Outside Sources of Information
From time to time, in reports and promotional literature: (1) the Fund's
total return performance, ranking, or any other measure of the Fund's
performance may be compared to any one or combination of the following: (i) a
broadbased index; (ii) other groups of mutual funds, including T. Rowe Price
Funds, tracked by independent research firms ranking entities, or financial
publications; (iii) indices of securities comparable to those in which the
Fund invests; (2) the Consumer Price Index (or any other measure for
inflation, government statistics, such as GNP may be used to illustrate
investment attributes of the Fund or the general economic, business,
investment, or financial environment in which the Fund operates; (3) various
financial,
<PAGE>
economic and market statistics developed by brokers, dealers and other
persons may be used to illustrate aspects of the Fund's performance; (4) the
effect of tax-deferred compounding on the Fund's investment returns, or on
returns in general in both qualified and nonqualified retirement plans or any
other tax advantage product, may be illustrated by graphs, charts, etc.; and
(5) the sectors or industries in which the Fund invests may be compared to
relevant indices or surveys in order to evaluate the Fund's historical
performance or current or potential value with respect to the particular
industry or sector.
Other Publications
From time to time, in newsletters and other publications issued by Investment
Services, T. Rowe Price mutual fund portfolio managers may discuss economic,
financial and political developments in the U.S. and abroad and how these
conditions have affected or may affect securities prices or the Fund;
individual securities within the Fund's portfolio; and their philosophy
regarding the selection of individual stocks, including why specific stocks
have been added, removed or excluded from the Fund's portfolio.
Other Features and Benefits
The Fund is a member of the T. Rowe Price family of Funds and may help
investors achieve various long-term investment goals, which include, but are
not limited to, investing money for retirement, saving for a down payment on
a home, or paying college costs. To explain how the Fund could be used to
assist investors in planning for these goals and to illustrate basic
principles of investing, various worksheets and guides prepared by T. Rowe
Price Associates, Inc. and/or Investment Services may be made available.
No-Load Versus Load and 12b-1 Funds
Unlike the T. Rowe Price funds, many mutual funds charge sales fees to
investors or use fund assets to finance distribution activities. These fees
are in addition to the normal advisory fees and expenses charged by all
mutual funds. There are several types of fees charged which vary in magnitude
and which may often be used in combination. A sales charge (or "load") can be
charged at the time the fund is purchased (front-end load) or at the time of
redemption (back-end load). Front-end loads are charged on the total amount
invested. Back-end loads or "redemption fees" are charged either on the
amount originally invested or on the amount redeemed. 12b-1 plans allow for
the payment of marketing and sales expenses from fund assets. These expenses
are usually computed daily as a fixed percentage of assets.
The Fund is a no-load fund which imposes no sales charges or 12b-1 fees.
No-load funds are generally sold directly to the public without the use of
commissioned sales representatives. This means that 100% of your purchase is
invested for you.
Redemptions in Kind
In the unlikely event a shareholder were to receive an in kind redemption of
portfolio securities of the Fund, brokerage fees could be incurred by the
shareholder in a subsequent sale of such securities.
CAPITAL STOCK
-------------------------------------------------------------------------------
Tax-Efficient Balanced, Tax-Free High Yield, Income, Intermediate Bond, and
Short-Intermediate Funds
The Fund's Charter authorizes the Board of Directors/Trustees to classify and
reclassify any and all shares which are then unissued, including unissued
shares of capital stock into any number of classes or series, each class or
series consisting of such number of shares and having such designations, such
powers, preferences, rights, qualifications, limitations, and restrictions,
as shall be determined by the Board subject to the Investment Company Act and
other applicable law. The shares of any such additional classes or series
might therefore differ from the shares of the present class and series of
capital stock and from each other as to preferences, conversions or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications or terms or conditions of redemption, subject to applicable
law, and might thus be superior or inferior to the
<PAGE>
capital stock or to other classes or series in various characteristics. The
Board of Directors/Trustees may increase or decrease the aggregate number of
shares of stock or the number of shares of stock of any class or series that
the Fund has authorized to issue without shareholder approval.
Except to the extent that the Fund's Board of Directors/Trustees might
provide by resolution that holders of shares of a particular class are
entitled to vote as a class on specified matters presented for a vote of the
holders of all shares entitled to vote on such matters, there would be no
right of class vote unless and to the extent that such a right might be
construed to exist under Maryland law. The Charter contains no provision
entitling the holders of the present class of capital stock to a vote as a
class on any matter. Accordingly, the preferences, rights, and other
characteristics attaching to any class of shares, including the present class
of capital stock, might be altered or eliminated, or the class might be
combined with another class or classes, by action approved by the vote of the
holders of a majority of all the shares of all classes entitled to be voted
on the proposal, without any additional right to vote as a class by the
holders of the capital stock or of another affected class or classes.
Tax-Efficient Balanced, Tax-Exempt Money, Tax-Free High Yield, Income,
Intermediate Bond, and Short-Intermediate Funds
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of directors/trustees (to the extent hereinafter provided) and on
other matters submitted to the vote of shareholders. There will normally be
no meetings of shareholders for the purpose of electing directors/trustees
unless and until such time as less than a majority of the directors/ trustees
holding office have been elected by shareholders, at which time the
directors/trustees then in office will call a shareholders' meeting for the
election of directors/trustees. Except as set forth above, the directors/
trustees shall continue to hold office and may appoint successor
directors/trustees. Voting rights are not cumulative, so that the holders of
more than 50% of the shares voting in the election of directors/trustees can,
if they choose to do so, elect all the directors/trustees of the Fund, in
which event the holders of the remaining shares will be unable to elect any
person as a director/trustee. As set forth in the By-Laws of the Fund, a
special meeting of shareholders of the Fund shall be called by the Secretary
of the Fund on the written request of shareholders entitled to cast at least
10% of all the votes of the Fund entitled to be cast at such meeting.
Shareholders requesting such a meeting must pay to the Fund the reasonably
estimated costs of preparing and mailing the notice of the meeting. The Fund,
however, will otherwise assist the shareholders seeking to hold the special
meeting in communicating to the other shareholders of the Fund to the extent
required by Section 16(c) of the Investment Company Act of 1940.
California and State Tax-Free Trusts
ORGANIZATION OF THE FUNDS
-------------------------------------------------------------------------------
Currently, the T. Rowe Price California Tax-Free Income Trust consists of two
series, California Tax-Free Bond Fund and California Tax-Free Money Fund, and
the T. Rowe Price State Tax-Free Income Trust consists of nine series,
Florida Intermediate Tax-Free Fund, Georgia Tax-Free Bond Fund, Maryland
Short-Term Tax-Free Bond Fund, Maryland Tax-Free Bond Fund, New Jersey
Tax-Free Bond Fund, New York Tax-Free Bond Fund, New York Tax-Free Money
Fund, Virginia Short-Term Tax-Free Bond Fund, and Virginia Tax-Free Bond Fund
each of which represents a separate class of each Trust's shares and has
different objectives and investment policies.
For tax and business reasons, the Funds were organized as Massachusetts
Business Trusts, and are registered with the Securities and Exchange
Commission under the Investment 1940 Act as diversified, open-end investment
companies, commonly known as "mutual fund."
The Declaration of Trust permits the Board of Trustees to issue an unlimited
number of full and fractional shares of a single class. The Declaration of
Trust also provides that the Board of Trustees may issue additional series or
classes of shares. Each share represents an equal proportionate beneficial
interest in the Fund. In the event of the liquidation of the Fund, each share
is entitled to a pro-rata share of the net assets of the Fund.
<PAGE>
Shareholders are entitled to one vote for each full share held (and
fractional votes for fractional shares held) and will vote in the election of
or removal of trustees (to the extent hereinafter provided) and on other
matters submitted to the vote of shareholders. There will normally be no
meetings of shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding office have
been elected by shareholders, at which time the trustees then in office will
call a shareholders' meeting for the election of trustees. Pursuant to
Section 16(c) of the 1940 Act, holders of record of not less than two-thirds
of the outstanding shares of the Fund may remove a trustee by a vote cast in
person or by proxy at a meeting called for that purpose. Except as set forth
above, the trustees shall continue to hold office and may appoint successor
trustees. Voting rights are not cumulative, so that the holders of more than
50% of the shares voting in the election of trustees can, if they choose to
do so, elect all the trustees of the Trust, in which event the holders of the
remaining shares will be unable to elect any person as a trustee. No
amendments may be made to the Declaration of Trust without the affirmative
vote of a majority of the outstanding shares of the Trust.
Shares have no preemptive or conversion rights; the right of redemption and
the privilege of exchange are described in the prospectus. Shares are fully
paid and nonassesable, except as set forth below. The Trust may be terminated
(i) upon the sale of its assets to another diversified, open-end management
investment company, if approved by the vote of the holders of two-thirds of
the outstanding shares of the Trust, or (ii) upon liquidation and
distribution of the assets of the Trust, if approved by the vote of the
holders of a majority of the outstanding shares of the Trust. If not so
terminated, the Trust will continue indefinitely.
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Fund. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations
of the Fund and requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Fund or a
Trustee. The Declaration of Trust provides for indemnification from Fund
property for all losses and expenses of any shareholder held personally
liable for the obligations of the Fund. Thus, the risk of a shareholder
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Fund itself would be unable to meet its
obligations, a possibility which T. Rowe Price believes is remote. Upon
payment of any liability incurred by the Fund, the shareholders of the Fund
paying such liability will be entitled to reimbursement from the general
assets of the Fund. The Trustees intend to conduct the operations of the Fund
is such a way so as to avoid, as far as possible, ultimate liability of the
shareholders for liabilities of such Fund.
FEDERAL REGISTRATION OF SHARES
-------------------------------------------------------------------------------
The Fund's shares are registered for sale under the Securities Act of 1933.
Registration of the Fund's shares is not required under any state law, but
the Fund is required to make certain filings with and pay fees to the states
in order to sell its shares in the states.
LEGAL COUNSEL
-------------------------------------------------------------------------------
Swidler Berlin Shereff Friedman, LLP, whose address is 919 Third Avenue, New
York, New York 10022-9998, is legal counsel to the Fund.
INDEPENDENT ACCOUNTANTS
-------------------------------------------------------------------------------
PricewaterhouseCoopers LLP, 250 West Pratt Street, 21st Floor, Baltimore,
Maryland 21201, are the independent accountants to the Funds.
<PAGE>
The financial statements of the Funds for the year ended February 28, 1998,
and the report of independent accountants are included in each Fund's Annual
Report for the year ended February 28, 1998. A copy of each Annual Report
accompanies this Statement of Additional Information. The following financial
statements and the report of independent accountants appearing in each Annual
Report for the year ended February 28, 1998, are incorporated into this
Statement of Additional Information by reference:
<TABLE>
<CAPTION>
ANNUAL REPORT REFERENCES:
CALIFORNIA FLORIDA GEORGIA
TAX-FREE FUNDS INTERMEDIATE TAX-FREE
-------------- TAX-FREE FUND BOND FUND
- ----------------------------------------------------------------- ---------
---------------------------
<S> <C> <C> <C>
Report of Independent Accountants 27 18 17
Statement of Net Assets, February
28, 1998 11-21 9-12 8-11
Statement of Operations, year
ended
February 28, 1998 22 13 12
Statement of Changes in Net
Assets, years ended
February 28, 1998 and February 28,
1997 23- 14 13
Notes to Financial Statements,
February 28, 1998 24-26 15-17 14-16
Financial Highlights 9-10 8 7
</TABLE>
<TABLE>
<CAPTION>
MARYLAND NEW JERSEY NEW YORK
TAX-FREE FUNDS TAX-FREE TAX-FREE FUNDS
-------------- BOND FUND --------------
---------
<S> <C> <C> <C>
Report of Independent Accountants 33 18 26
Statement of Net Assets, February
28, 1998 11-27 7-12 11-20
Statement of Operations, year
ended
February 28, 1998 28 13 21
Statement of Changes in Net
Assets, years ended
February 28, 1998 and February
28, 1997 29 14 22
Notes to Financial Statements,
February 28, 1998 30-32 15-17 23-25
Financial Highlights 9-10 6 9-10
</TABLE>
<TABLE>
<CAPTION>
VIRGINIA TAX-EXEMPT TAX-FREE HIGH
TAX-FREE MONEY FUND YIELD FUND
FUNDS ---------- ----------
-----
<S> <C> <C> <C>
Report of Independent Accountants 26 20 31
Statement of Net Assets, February 28,
1998 11-20 3-15 3-25
Statement of Operations, year ended
February 28, 1998 21 16 26
Statement of Changes in Net Assets,
years ended
February 28, 1998 and February 28, 1997 22 17 27
Notes to Financial Statements, February
28, 1998 23-25 18-19 28-30
Financial Highlights 9-10 2 2
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
TAX-FREE TAX-FREE
TAX-FREE INTERMEDIATE SHORT-
INCOME FUND BOND FUND INTERMEDIATE
----------- --------- FUND
----
<S> <C> <C> <C>
Report of Independent Accountants 27 14 15
Statement of Net Assets, February
28, 1998 3-21 3-8 3-10
Statement of Operations, year ended
February 28, 1998 22 9 11
Statement of Changes in Net Assets,
years ended
February 28, 1998 and February 28,
1997 23 10 12
Notes to Financial Statements,
February 28, 1998 24-26 11-13 13-14
Financial Highlights 2 2 2
</TABLE>
<TABLE>
<CAPTION>
TAX-EFFICIENT
BALANCED FUND
-------------
<S> <C>
Report of Independent Accountants 28
Portfolio of Investments, February 28, 1998 9-20
Statement of Assets and Liabilities, February 28, 1998 21
Statement of Operations, period from June 30, 1997
(commencement of operations) to February 28, 1998 22
Statement of Changes in Net Assets, period from June
30, 1997 (commencement of operations) to February 28,
1998 23
Notes to Financial Statements, February 28, 1998 24-27
Financial Highlights 8
</TABLE>
RATINGS OF MUNICIPAL DEBT SECURITIES
-------------------------------------------------------------------------------
Moody's Investors Services, Inc. (Moody's)
Aaa-Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edge."
Aa-Bonds rated Aa are judged to be of high quality by all standards. Together
with the Aaa group they comprise what are generally know as high-grade bonds.
A-Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium-grade obligations.
Baa-Bonds rated Baa are considered as medium-grade obligations, i.e., they
are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any
great length of time. Such bonds lack outstanding investment characteristics
and in fact have speculative characteristics as well.
Ba-Bonds rated Ba are judged to have speculative elements: their futures
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterize bonds in this class.
<PAGE>
B-Bonds rated B generally lack the characteristics of a desirable investment.
Assurance of interest and principal payments or of maintenance of other terms
of the contract over any long period of time may be small.
Caa-Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or
interest.
Ca-Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked short-comings.
C-Bonds rated C represent the lowest-rated, and have extremely poor prospects
of attaining investment standing.
Standard & Poor's Corporation (S&P)
AAA-This is the highest rating assigned by Standard & Poor's to a debt
obligation and indicates an extremely strong capacity to pay principal and
interest.
AA-Bonds rated AA also qualify as high-quality debt obligations. Capacity to
pay principal and interest is very strong.
A-Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds
in this category than for bonds in the A category.
BB, B, CCC, CC, C-Bonds rated BB, B, CCC, and CC are regarded on balance, as
predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal. BB indicates the lowest degree of speculation
and CC the highest degree of speculation. While such bonds will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
D-In default.
Fitch IBCA, Inc.
AAA-High grade, broadly marketable, suitable for investment by trustees and
fiduciary institutions, and liable to but slight market fluctuation other
than through changes in the money rate. The prime feature of a "AAA" bond is
the showing of earnings several times or many times interest requirements for
such stability of applicable interest that safety is beyond reasonable
question whenever changes occur in conditions. Other features may enter, such
as wide margin of protection through collateral, security or direct lien on
specific property. Sinking funds or voluntary reduction of debt by call or
purchase or often factors, while guarantee or assumption by parties other
than the original debtor may influence their rating.
AA-Of safety virtually beyond question and readily salable. Their merits are
not greatly unlike those of "AAA" class but a bond so rated may be junior
though of strong lien, or the margin of safety is less strikingly broad. The
issue may be the obligation of a small company, strongly secured, but
influenced as to rating by the lesser financial power of the enterprise and
more local type of market.
A-Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB-Bonds rated BBB are considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions ad
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore
<PAGE>
impair timely payment. The likelihood that the ratings of these bonds will
fall below investment grade is higher than for bonds with higher ratings.
BB, B, CCC, CC, and C are regarded on balance as predominantly speculative
with respect to the issuer's capacity to repay interest and repay principal
in accordance with the terms of the obligation for bond issues not in
default. BB indicates the lowest degree of speculation and C the highest
degree of speculation. The rating takes into consideration special features
of the issue, its relationship to other obligations of the issuer, and the
current and prospective financial condition and operating performance of the
issuer.
RATINGS OF MUNICIPAL NOTES AND VARIABLE RATE SECURITIES
-------------------------------------------------------------------------------
Moody's Investors Service, Inc. VMIG1/MIG-1 the best quality. VMIG2/MIG-2
high quality, with margins of protection ample though not so large as in the
preceding group. VMIG3/MIG-3 favorable quality, with all security elements
accounted for, but lacking the undeniable strength of the preceding grades.
Market access for refinancing, in particular, is likely to be less well
established. VMIG4/MIG-4 adequate quality but there is specific risk.
Standard & Poor's Corporation SP-1 very strong or strong capacity to pay
principal and interest. Those issues determined to possess overwhelming
safety characteristics will be given a plus (+) designation. SP-2
satisfactory capacity to pay interest and principal. SP-3 speculative
capacity to pay principal and interest.
Fitch IBCA, Inc. F-1+ exceptionally strong credit quality, strongest degree
of assurance for timely payment. F-1 very strong credit quality. F-2 good
credit quality, having a satisfactory degree of assurance for timely payment.
F-3 fair credit quality, assurance for timely payment is adequate but adverse
changes could cause the securities to be rated below investment grade. F-5
weak credit quality, having characteristics suggesting a minimal degree of
assurance for timely payment.
RATINGS OF COMMERCIAL PAPER
-------------------------------------------------------------------------------
Moody's Investors Services, Inc. P-1 superior capacity for repayment. P-2
strong capacity for repayment. P-3 acceptable capacity for repayment of
short-term promissory obligations.
Standard & Poor's Corporation A-1 highest category, degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation. A-2 satisfactory capacity to pay principal and interest. A-3
adequate capacity for timely payment, but are vulnerable to adverse effects
of changes in circumstances than higher-rated issues. B and C speculative
capacity to pay principal and interest.
Fitch IBCA, Inc. F-1+ exceptionally strong credit quality, strongest degree
of assurance for timely payment. F-1 very strong credit quality. F-2 good
credit quality, having a satisfactory degree of assurance for timely payment.
F-3 fair credit quality, assurance for timely payment is adequate but adverse
changes could cause the securities to be rated below investment grade. F-5
weak credit quality, having characteristics suggesting a minimal degree of
assurance for timely payment.
November 4, 1998
Laura J. Riegel, Esq.
Securities and Exchange Commission
Division of Investment Management
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: T. Rowe Price Tax-Exempt Money Fund, Inc. - PLUS Class
File Nos.: 002-67029/811-3055
Dear Ms. Riegel:
In accordance with the provisions of Rule 497 of the Securities Act of 1933, we
are hereby filing the above-captioned fund's Statement of Additional Information
dated November 1, 1998, which will be used for the offer and sale of fund
shares. All changes have been redlined.
This Statement of Additional Information and the prospectus were filed as part
of Post-Effective Amendment No. 34, dated August 28, 1998, as an amendment to
the Registration Statement on Form N-1A. They went effective on November 1,
1998.
Sincerely,
/s/Forrest R. Foss
Forrest R. Foss
